INTERNATIONAL FINANCE

UNIT II: International Monetary and Financial System: Importance of

international finance; Bretton woods conference and afterwards, IMF and the
World Bank; European monetary system - meaning and scope.

What is Globalisation

Over many centuries, human societies across the globe have

established progressively closer contacts. Recently, the pace of global
integration has dramatically increased. Unprecedented changes in
communications, transportation, and computer technology have given
the process new impetus and made the world more interdependent
than ever. Multinational corporations manufacture products in many
countries and sell to consumers around the world. Money, technology
and raw materials move ever more swiftly across national borders.
Along with products and finances, ideas and cultures circulate more
freely. As a result, laws, economies, and social movements are forming
at the international level.

Advantages

Increased free trade between nations

Increased liquidity of capital allowing investors in developed
nations to invest in developing nations
Corporations have greater flexibility to operate across borders
Global mass media ties the world together
Increased flow of communications allows vital information to be
shared between individuals and corporations around the world
Greater ease and speed of transportation for goods and people
Reduction of cultural barriers increases the global village effect
Spread of democratic ideals to developed nations
Greater interdependence of nation-states
Reduction of likelihood of war between developed nations
Increases in environmental protection in developed nations

Disadvantages

Increased flow of skilled and non-skilled jobs from developed to

developing nations as corporations seek out the cheapest labor
Increased likelihood of economic disruptions in one nation
affecting all nations
Corporate influence of nation-states far exceeds that of civil
society organizations and average individuals
Threat that control of world media by a handful of corporations
will limit cultural expression

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 Greater chance of reactions for globalization being violent in an
attempt to preserve cultural heritage
Greater risk of diseases being transported unintentionally
between nations
Spread of a materialistic lifestyle and attitude that sees
consumption as the path to prosperity
International bodies like the World Trade Organization infringe on
national and individual sovereignty
Increase in the chances of civil war within developing countries
and open war between developing countries as they vie for
resources
Decreases in environmental integrity as polluting corporations
take & advantage of weak regulatory rules in developing
countries

What are the merits and demerits of MNCs?

Ans: Jacques Maisonrouge, president of IBM world trade corporations defines an MNC
as a company that meets five criteria:
1) It operates in many countries at different levels of economic developments.
2) Nationals manage its local subsidiaries.
3) It maintains complete industrial organizations, including R and d and manufacturing
facilities in several countries.
4) It has a multinational central management.
5) It has multinational stock ownership.

James C. Baker also defines MNCs as a company:

1) Which has direct investment base in several countries.
2) Which generally derives from 20% to 50% or more its net profits from foreign
operations.
3) Whose management makes policy decisions based on the alternatives available
anywhere in the world.

A significant share of the worlds industrial investment, production, employment and

trade are accounted for by these more than 65000 MNCs with over 8,00,000 affiliates.

MERITS OF THE MNCS: -

Multinationals offer advantages to host countries as well as to the countries of their

origin as explained below:

Advantages of the MNCs to the host countries: -

1) Raise the rate of investment: - MNCs raise the rate of investment in the host
countries and thereby bring rapid industrial growth accompanied by massive
employment opportunities in different sectors of the economy.
2) Facilitate transfer of technology: -Multinationals act as agents for the transfer of

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technology to developing countries and thereby help such countries to modernize there
industries. They remove technological gaps in developing countries by providing
techno-managerial skills.
3) Accelerate industrial growth: - multinationals accelerate industrial growth in host
countries through collaborations, joint ventures and establishment of subsidiaries and
branches. They facilitate economic growth through financial, marketing and
technological services. MNCs are rightly called messengers of progress.
4) Promote export and reduce imports: - MNCs help the host countries to reduce the
imports and promote the exports by raising domestic production. Marketing facilities at
global level are provided by MNCs due to their global business contacts.
5) Provide services to professionals: - MNCs provide the services of the skilled
professional managers for managing the activities of the enterprises in which they are
involved/interested. This raises overall managerial efficiency or enterprises connected
with multinationals. MNCs bring managerial revolution in host countries.
6) Facilitate efficient utilization of resources: - Multinationals facilitate efficient
utilization of resources available in host countries. This leads to economic
development.
7) Provide benefits of R and D activities: -Multinationals has enormous resources at
their disposal. Some are utilized for R and D activities. The benefits of R and D
activities are passed on to the enterprises operating in the host countries.
8) Support enterprises in host countries: - MNCs support to enterprises in the host
countries in order to support their own operations indirectly. This is how MNCs
support enterprises in the host countries to grow. Even consumers get new goods and
services due to the operations of MNCs.
9) Break domestic monopolies: - MNCs raise competition in the host countries and
thereby break domestic monopolies.

ADVANTAGES OF MULTINATIONALS TO COUNTRIES OF THEIR ORIGIN:

-
1) Facilitate inflow of foreign exchange: - MNCs collect funds from the enterprises of
other countries in the form of fees, royalty, and service charges. This money is taken to
the country of their origin. MNCs make their home countries rich by facilitating inflow
of foreign exchange from other countries.
2) Promote global co-operations: - MNCs provide co-operation to poor or developing
countries to develop their industries. The countries of their origin participate in such
international co-operation, which is beneficial to all countries- rich and poor.
3) Ensure optimum utilization of resources: -MNCs ensure optimum utilization of
natural and other resources available in their home countries. This is possible due to
their worldwide business contacts.
4) Promote bilateral trade relations: -MNCs facilitate bilateral trade relations between
their home countries and the other countries with which they have business relations.

DEMERITS OF MULTINATIONAL COMPANIES: -

1) Provide outdated technologies: - MNCs design the technologies, which can be used
in different countries. They dont supply technology to poor countries for industrial
development but for profit maximization. The technologies designed for profit

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maximization and not purely for meeting the needs of developing countries. The
technologies supplied may be costly and may be outdated and obsolete or may not be
suitable for the needs of developing countries.
2) Harm the national interests: - the activities of MNCs in the host countries may be
harmful to the national interests as MNCs are solely guided by the profit
maximization. They ignore the interests of host countries. MNCs even make profits at
the cost of developing countries.
3) Charge heavy fees: - MNCs charge heavy fees and service charges from the
enterprises in the host countries. They repatriate profits of their subsidiaries to their
home countries. This leads the outflow of countries.
4) Develop monopolies: - MNCs restrict competition and acquire monopoly power in
certain areas in the host countries.
5) Use resources recklessly: -MNCs use the resources in the host countries in a very
reckless manner, which leads to fast reduction of non-renewable natural resources.
6) Dominate domestic policies: -MNCs use their money power for political purposes.
They take undue interest in political matters in the host countries. MNCs are being
openly termed as an extension of the imperialistic forces.
7) Adverse effects on life style/culture in the host countries: - MNCs create demand for
goods and services in developing countries through advertising and sales promotion
techniques. As a result, people purchase costly/ luxury goods which are not really
useful nor within their capacity to purchase. MNCs create adverse effects on the
cultural background of many developing countries.
8) Interfere in economic and political systems: - they put indirectly pressures for the
formulation of policies that are favorable to them. They even topple the government in
the host countries if its policies are against the MNCs and their operations.
9) Avoid tax liabilities: - transfer pricing enables multinational corporations to avoid
taxes by manipulating prices in the case of intra company transactions.
10) Lead to brain drain in developing countries: - multinationals are now entering in
countries like India in a bigger way. They hire qualified technocrats and managerial
experts. These people work for a few years in India, acquire experience and relocated
as experts in Singapore, Korea or the United States for managing the activities of
MNCs. This leads to brain drain in developing countries.

MNCS have helped and also harmed the developing countries. It is a peculiar mixture
of virtues and vices, boons and banes. However no country can afford to avoid MNCs
only because it has dangers associated with them. It may be concluded that MNCs
constitute a mixed blessing to developing countries. They are helping as well as
harming the developing countries. It is rightly said MNCs are bound to exist and
eveloping countries have to learn to live with Them.

GROWTH OF MNCs

The MNCs share in global investment, production, employment and trade has assumed
considerable proportions.
According to the UN, there are 63,000 MNCs with 6,90,000 affiliates all over the globe
with 2,40,000 in China and only 1400 in India. The US was the forerunner in giving

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births to MNCs. Today, biggest MNCs are Japanese. T
He global liberalization wave, paved the path for faster expansion and growth of
MNCs. The value added by the foreign affiliates of MNCs, as a percentage of global
GDP grew from 5% in the 1980s to about 7% by the end of 90s. The MNCs control
about a third of world output and the total sales of their foreign affiliates is almost equal
to the GNP of all developing countries. The value of the annual sales of the largest
manufacturing multinational General Motors, was about $178bn in 1996. The total
sales of the 3 largest automobile firms of the world, namely, General Motors, Ford and
Toyota is greater than the value of Indias GDP.
In terms of direct employment, the MNCs accounted for 73mn people worldwide and if
indirect employment is considered, the figure approximates 150mn people. Over 350m
people were employed by the foreign affiliates of MNCs in 1988.
A number of factors have contributed to the phenomenal growth of MNCs. Some of the
important factors are as follows: -

1) Expansion of market territories: -

Rapid economic growth in a number of countries resulting in rising GDPs and per
capita incomes contributed to the growing standards of living. This in turn contributed
to the continuous expansion of market territories. MNCs, both contributed to the
expansion of market territories and also grew in size and spread as a result of expansion
of market territories.

2) Market superiorities: -
In many ways, MNCs have an edge over domestic firms, such as: -
a) Availability of reliable and current data,
b) MNCs enjoy market reputation,
c) MNCs encounters relatively less problems and difficulties in marketing the products,
d) MNCs adopt more effective advertising and sales promotion techniques, and
e) MNCs enjoy faster transportation and adequate warehousing facilities

3)Financial superiorities: -
MNCs also enjoy a number of financial advantages over domestic firms. These are: -
a) Availability of huge financial resources with the MNCs helps them to transform
business environment and circumstances in their favor.
b) MNCs can use the funds more effectively and economically on account of their
activities in numerous countries.
c) MNCs have easy access to international capital markets, and
d) MNCs have easy assessed to international banks and financial institutions.

4) Technological superiorities: -
MNCs are technologically prosperous on account of high and sustained spend on R&D.
developing countries on account of their technological backwardness welcome MNCs
to their countries because of the attendant benefits of technology transfer.

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INTERNATIONAL MONETARY SYSTEM.

Gold standard

The gold standard is a monetary system in which the standard economic unit of account
is a fixed weight of gold. There are distinct kinds of gold standard.

First, the gold specie standard is a system in which the monetary unit is associated with
circulating gold coins, or with the unit of value defined in terms of one particular
circulating gold coin in conjunction with subsidiary coinage made from a lesser valuable
metal.

Similarly, the gold exchange standard typically involves the circulation of only coins
made of silver or other metals, but where the authorities guarantee a fixed exchange rate
with another country that is on the gold standard. This creates a de facto gold standard, in
that the value of the silver coins has a fixed external value in terms of gold that is
independent of the inherent silver value.

Finally, the gold bullion standard is a system in which gold coins do not circulate, but in
which the authorities have agreed to sell gold bullion on demand at a fixed price in
exchange for the circulating currency.

Floating exchange rate

A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime
wherein a currency's value is allowed to fluctuate according to the foreign exchange
market. A currency that uses a floating exchange rate is known as a floating currency. It is
not possible for a developing country to maintain the stability in the rate of exchange for
its currency in the exchange market.

There are economists who think that, in most circumstances, floating exchange rates are
preferable to fixed exchange rates. As floating exchange rates automatically adjust, they
enable a country to dampen the impact of shocks and foreign business cycles, and to
preempt the possibility of having a balance of payments crisis. However, in certain
situations, fixed exchange rates may be preferable for their greater stability and certainty.
This may not necessarily be true, considering the results of countries that attempt to keep
the prices of their currency "strong" or "high" relative to others, such as the UK or the
Southeast Asia countries before the Asian currency crisis. In cases of extreme
appreciation or depreciation, a central bank will normally intervene to stabilize the
currency. Thus, the exchange rate regimes of floating currencies may more technically be
known as a managed float. A central bank might, for instance, allow a currency price to
float freely between an upper and lower bound, a price "ceiling" and "floor".
Management by the central bank may take the form of buying or selling large lots in
order to provide price support or resistance, or, in the case of some national currencies,
there may be legal penalties for trading outside these bounds.

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Fixed exchange rate

A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange
rate regime wherein a currency's value is matched to the value of another single currency
or to a basket of other currencies, or to another measure of value, such as gold.

A fixed exchange rate is usually used to stabilize the value of a currency against the
currency it is pegged to. This makes trade and investments between the two countries
easier and more predictable, and is especially useful for small economies where external
trade forms a large part of their GDP.

It can also be used as a means to control inflation. However, as the reference value rises
and falls, so does the currency pegged to it. In addition, according to the Mundell-
Fleming model, with perfect capital mobility, a fixed exchange rate prevents a
government from using domestic monetary policy in order to achieve macroeconomic
stability.

There are no major economic players that use a fixed exchange rate (except the countries
using the Euro and the Chinese Yuan). The currencies of the countries that now use the
euro are still existing (e.g. for old bonds). The rates of these currencies are fixed with
respect to the euro and to each other. The most recent such country to discontinue their
fixed exchange rate was the People's Republic of China, which did so in July 2005.
However, as of September 2010, the fixed-exchange rate of the Chinese Yuan has already
increased 1.5% in the last 3 months.

The Bretton Woods System

Until World War II, the British pound was the dominant world currency, and the one
against which most other currencies were compared. the U.S. dollar and British pound
were the first currencies traded by telegraphic cable. The U.S. economy was booming,
and the United States emerged as a world economic power. When the United Nations
Monetary Fund convened in Bretton Woods, New Hampshire, representatives of the
United States, Great Britain and France attended to work on a design for a new global
economic order. The U.S. dollar was now the world's benchmark currency, and it
became the currency against which other nations would measure their own currencies
as they struggled to rebuild themselves.
The world was in a shambles - The Bretton Woods Accord established the policy of
pegging currencies against the U.S. dollar so as to bring stability to a fractured and
volatile global economic situation.
The first element of the Accord was to peg the U.S. dollar to the price of gold at $35.00
an ounce. (The gold standard). With this benchmark anchoring the U.S. dollar, other
major currencies were pegged to the greenback and allowed to fluctuate not more than
1 % on either side of the pegged rate. If the rate did move more than one percent, the
central bank of that country was required to intervene in the market until the exchange
rate was brought back within the one percent band.

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The Bretton Woods Accord ultimately failed in its objective of helping to establish
economic stability in Japan and Europe, but endured until 1971.
The European Monetary System
In the early days of the European Union, back when it was know as the European
Economic Community, the Europeans sought to manage the value of their currencies
against each other. They created the European Monetary System. Their currencies were
pegged against each other, and the signatories of the EMS agreed to intervene if their
currencies moved more than 2% away from the pegged rate.
In 1993, the European Monetary System failed when currency traders made a
speculative attack on the British pound. As required by the European Monetary System
Agreement, the Bank of England intervened to manage the pound's exchange rate.
However, the currency market was now so large and so much of the world's currency
reserves were in the hands of private traders, that it proved to be too expensive for the
Bank of England to manage its exchange rate. The United Kingdom announced its
withdrawal from the EMS and the system failed, paving over the final obstacle to the
true free-float system we know today.
INTERNATIONAL FINANCE: It includes

(INTERATIONALMARKETS (Money Market, Capital Market)

INTERNATIONAL INSTITUTIONS (IMF, world bank etc.)
INTERNATIONAL INSTRUMENTS,(CPs, CDs, bills short term money
market, bonds and equity(ADR and GDR) in capital market.)

International markets:

Money Market:

Eurocurrency market, Asian Currency Market

Definition:
The market where financial banking institutions provide banking services denominated in
foreign currencies. They may accept deposits and provide loans. Unlike Euro credit
markets, however, loans in this market are made short-term.
The Eurobond market:

The Eurobond market is made up of investors, banks, borrowers, and trading agents that
buy, sell, and transfer Eurobonds. Eurobonds are a special kind of bond issued by
European governments and companies, but often denominated in non-European
currencies such as dollars and yen. They are also issued by international bodies such as
the World Bank. The creation of the unified European currency, the euro, has stimulated

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strong interest in euro-denominated bonds as well; however, some observers warn that
new European Union tax harmonization policies may lessen the bonds' appeal.

Eurobonds are unique and complex instruments of relatively recent origin. They debuted
in 1963, but didn't gain international significance until the early 1980s. Since then, they
have become a large and active component of international finance. Similar to foreign
bonds, but with important differences, Eurobonds became popular with issuers and
investors because they could offer certain tax shelters and anonymity to their buyers.
They could also offer borrowers favorable interest rates and international exchange
rates.

International institutions

The most prominent international institutions are the IMF, the World Bank and the WTO:

The International Monetary Fund keeps account of international balance of

payments accounts of member states. The IMF acts as a lender of last resort for
members in financial distress, e.g., currency crisis, problems meeting balance of
payment when in deficit and debt default. Membership is based on quotas, or the
amount of money a country provides to the fund relative to the size of its role in
the international trading system.
The World Bank aims to provide funding, take up credit risk or offer favourable
terms to development projects mostly in developing countries that couldn't be
obtained by the private sector. The other multilateral development banks and other
international financial institutions also play specific regional or functional roles.
The World Trade Organization settles trade disputes and negotiates international
trade agreements in its rounds of talks (currently the Doha Round).

Also important is the Bank for International Settlements, the intergovernmental

organisation for central banks worldwide. It has two subsidiary bodies that are important
actors in the global financial system in their own right - the Basel Committee on Banking
Supervision, and the Financial Stability Board.

In the private sector, an important organisation is the Institute of International Finance,

which includes most of the world's largest commercial banks and investment banks.

Financial Instruments in last sem FE notes