International Finance

Chapter 1
Introduction
International Business

International finance
International finance is the branch of
economics that studies the dynamics of
exchange rates, foreign investment,
global financial system, and how these
affect international trade.
It also studies international projects,
international investments and capital
flows, and trade deficits. It includes the
study of futures, options and currency
swaps. International finance is a branch
of international economics
2

Whats Special about

International Finance?

Foreign Exchange Risk

Political Risk
Market Imperfections
Expanded Opportunity Set

Whats Special about

International Finance?
Foreign Exchange Risk:
-The risk that foreign currency profits
may evaporate in dollar terms due
to unanticipated unfavorable
exchange rate movements.
Political Risk:
-Sovereign governments have the
right to regulate the movement of
goods, capital, and people across
their borders. These laws sometimes
4

Whats Special about

International Finance?

Market Imperfections
Legal restrictions on movement of
goods, people, and money
Transactions costs
Shipping costs
Tax arbitrage
Expanded Opportunity Set
It doesnt make sense to play in only one
corner of the sandbox.
True for corporations as well as individual
5
investors.

International Business

All the business transactions

(exchanges of money)
necessary for creating,
shipping, and selling goods
and services across national
borders. Also referred to
international trade or foreign
trade.
6

International Business Terminology

Domestic Transaction
Selling of goods produced in the same country.
For example: You visit a store in your community (local store)
and purchase a bicycle that has been manufactured in India.
International Transaction
-Selling goods produced in another country.
-Involves creating, shipping, and selling goods and services
across national borders.
-Also referred to as international trade or foreign trade.
-For example: You go to Indian Accessory Shop and purchase a
tool that was manufactured in China or Japan.
Imports : A good or service brought into Canada from
another country. (made in China)
Exports : A product or service produced in Canada and sold
in another country. (made in Canada and sold
in US)
7

International Business Terminology

Trade Deficit
When India imports more goods than it
exports, we have what is called a Trade
Deficit.
Imports > Exports = Trade Deficit
Trade Surplus
When India exports more goods than it
imports, we have a Trade Surplus.
Exports > Imports = Trade Surplus
Which do you think is better for the Indian
economy?
8

Five Ps of International
Business
Product: A countrys resources determine what
goods and services it can produce.
Price: Cost of producing goods and services
varies from one country to another.
Proximity: Proximity to a fellow neighboring
country allows for a company and/or country to
benefit from doing business across the border.
Preference: Some countries specialize in certain
goods or services that have a reputation for
quality all over the world.
Promotion: The internet and satellite
broadcasting have made it easier to inform people
around the world about goods and services
9
available.

Theories of International
Business
Why are firms motivated to expand their
business internationally?

Theory of Comparative Advantage

Specialization by countries can increase
production efficiency.
Different costs/skills between nations

Imperfect Markets Theory

The markets for the various resources used in
production are imperfect.
immobility of factors of production

Product Cycle Theory

As a firm matures, it may recognize
10
additional opportunities outside its
home

International Business
Methods

There are several methods by which firms

can conduct international business.

International trade is a relatively

conservative approach involving
exporting and/or importing.
The internet facilitates international trade by
enabling firms to advertise and manage
orders through their websites.

Licensing allows a firm to provide its

technology in exchange for fees or some
other benefits.
11

International Business
Methods
Franchising obligates a firm to provide a
specialized sales or service strategy, support
assistance, and possibly an initial investment in the
franchise in exchange for periodic fees.
McDonalds, PizzaHut.
Firms may also penetrate foreign markets by
engaging in a joint venture (joint ownership and
operation) with firms that reside in those markets.
GenMills cereals sold through Nestles distribution
network
Acquisitions of existing operations in foreign
countries allow firms to quickly gain control over
foreign operations as well as a share of the foreign
market.
12
P&G bought bleach company in Panama

International Business
Methods

Firms can also penetrate foreign

markets by establishing new
foreign subsidiaries.
In general, any method of conducting
business that requires a direct
investment in foreign operations is
referred to as a direct foreign
investment (FDI).
The optimal international business
method may depend on the
13

International
Opportunities

Investment opportunities - The

marginal return on projects for an MNC is
above that of a purely domestic firm
because of the expanded opportunity set
of possible projects from which to select.
Financing opportunities - An MNC is
also able to obtain capital funding at a
lower cost due to its larger opportunity
set of funding sources around the world.
14

International Opportunities
Opportunities in Europe
The Single European Act of 1987.
Uniform regulations & removal tariffs

The removal of the Berlin Wall in 1989.

Expand into eastern Europe

The inception of the euro in 1999.

transparency

Opportunities in Latin America

The North American Free Trade Agreement
(NAFTA) of 1993.
US, Mexico, Canada

The General Agreement on Tariffs and Trade

(GATT) accord.
15

International Opportunities

Opportunities in Asia
The reduction of investment
restrictions by many Asian
countries during the 1990s.
Miller licensing & Annheuser Busch
bought Chinese beer co.

Chinas potential for growth.

The Asian economic crisis in 19971998.
16

Exposure to
International Risk

International business usually increases an MNCs

exposure to:

exchange rate movements

Exchange rate fluctuations affect cash flows
and foreign demand.

foreign economies
Economic conditions affect demand.

political risk
Political actions affect cash flows.
Terrorism 9/11/01 MNC from 50 countries had
office space in WTC
17

Global-Level Cooperation
Among Nations

The World Trade Organization (WTO),

World Bank, and
International Monetary Fund (IMF)
are three fundamental institutions
affecting global cooperation of nations.
The IMF and World Bank serve as a
financial base for cooperation.
The WTO serves as the institutional
foundation of the world trading system.
18

Multinational Corporations
A firm that has incorporated on one
country and has production and sales
operations in other countries.
Goal of MNC: The commonly accepted
goal of an MNC is to maximize
shareholder wealth.
There are about 60,000 MNCs in the
world.
Many MNCs obtain raw materials from
one nation, financial capital from
19

THE RISE OF THE MULTINATIONAL

CORPORATION

EVOLUTION OF THE MNC

Reasons to Go Global:

1. raw materials
2. more markets
3. minimize costs of production

1.RAW MATERIAL SEEKERS

exploit markets in other countries
historically first to appear
modern-day counterparts

Anaconda Copper
Standard Oil
20

THE RISE OF THE MULTINATIONAL

CORPORATION

2. MARKET SEEKERS

produce and sell in foreign markets

heavy foreign direct investors
representative firms:
IBM
Nestle
Levi Strauss

3. COST MINIMIZERS

seek lower-cost production abroad

motive: to remain cost competitive
representative firms:
Texas Instruments
Atari
Zenith
21

Top 10 MNCs
1
2

General Electric
Ford Motor Company

United States
United States
Netherlands/ UK

Conflicts Against the

MNC Goal
For corporations with shareholders who differ

from their managers, a conflict of goals can

exist - the agency problem.
Agency costs are normally larger for MNCs than
for purely domestic firms.

The sheer size of the MNC.

The scattering of distant subsidiaries.
The culture of foreign managers.
Subsidiary value versus overall MNC value.

The magnitude of agency costs can vary with

the management style of the MNC.
A centralized management style reduces
agency costs. However, a decentralized style
gives more control to those managers
who are
23

Impact of Management
Control

Some MNCs attempt to strike a

balance - they allow subsidiary
managers to make the key decisions
for their respective operations, but
the decisions are monitored by the
parents management.
Example of conflict: Subsidiary manager
looks at cost & benefit of project but
neglected to realize that any earnings
from the project would be heavily taxed
by host government => subsidiarys
24

Impact of Management
Control

Electronic networks make it easier for the

parent to monitor the actions and
performance of foreign subsidiaries.
For example, corporate intranet or
internet email facilitates communication.
Financial reports and other documents
can be sent electronically too.
Various forms of corporate control can
reduce agency costs.
Stock compensation for board members and
executives.
The threat of a hostile takeover. 25

Constraints
Interfering with the MNCs
Goal
As MNC managers attempt to
maximize their firms value, they
may be confronted with various
constraints.
Environmental constraints.
Differ e.g., pollution controls

Regulatory constraints.
Taxes, currency convertibility, earnings
remitting

Ethical constraints.

26

 Globalization &
its
Impact
27

Mile Stone Events That Have

Affected Business

End of World War I

(1918)
End of World War II
(1945)
End of Cold War
(1989)
9/11
(2001)
Global Financial Market crisis
(2008)
28

Globalization
Globalization refers to growing interdependence
of countries resulting from the increasing
integration of trade, finance, people, and ideas in
one global
marketplace.
International trade and cross-border investment
flows are the main elements of this integration.
Globalization is a process which tends to increase
the interdependence, integration and links
between economies of various nations.
Globalization means having large scale
production cum marketing operations of the
firms around the world.
29

Globalization
In economics, globalization is the convergence of
prices, products, wages, rates of interest and profits
towards developed country norms.
Globalization is the process consist of integration of
product and resource markets across nations via
trade, immigration, foreign investment, noneconomic
elements like culture and environment.
Globalization means the removal of barriers to free
trade and the closer integration of national
economies can be a force for good that has the
potential to enrich everyone in the world, particularly
the poor, but the way it has been managed
(especially the international trade agreements)
needs to be rethought. Joseph Stieglitz 3.0

Globalization

Globalization is the acceleration

and intensification of interaction
and integration among the
people, companies, and
governments of
different nations.
This process has effects on human well-being
(including health and personal safety), on the
environment, on culture (including ideas,
religion, and political systems), and31 on
economic development and prosperity of

Definition: Globalization
A Preliminary Definition
an unprecedented compression of time and
space reflected in the tremendous intensification
of social, political, economic, and cultural
interconnections and interdependencies on a
global scale.
Stegler, p. ix

time-space compression.
deterritorialization and supraterritoriality :
In a world of deterritorialization and supraterritoriality:
Distance becomes almost irrelevant (the end of
distance)
Boundaries are increasingly permeable.
Groups and cultures increasingly dont have a territorial
basis
(deterritorialization)
32

Definition: Globalization
One way to approach this: think about
the world before globalization
Distance matteredspace often
measured in time
Territorial boundaries more or less
kept things in and out
Society and culture had spatial
referents
Everything had its place (literally)
33

Globalization

Forces driving globalization?

1. The technological change since industrial

revolution led to explosion of productivity and

slashed transportation cost.
2. Electricity, telephone , automobile, pipelines
altered the communication and transportation
ways .
3.The rapid development in computer information
and communication technology have shrunk the
influence of time and geography on the capacity
of individual and enterprises to interact and
transact around the world.
4.The liberalization of trade and investment
34

5.DIMENSIONS OF GLOBALIZATION

Each discipline constructs a concept of globalization that reflects

its special point of view: Consider how it relates its focal concerns
to the contemporary world system

Economics: globalization = trade, money,

corporations, banking, capital
Political science: globalization = governance,
war, peace, IGOs, NGOs, regimes
Sociology: globalization = communities,
conflict, classes, nations, agreements
Psychology: globalization = individuals as
subjects and objects of global action
Anthropology: globalization = cultures
35
overlapping, adapting, clashing, merging

Globalization and Its

Impact
Effects of globalization on:
1. Globalization and Management:
-The skill and cost advantage that drive globalization efforts also
impact the way people are managed in organization. The older
personal management and Theory X approach have given way to
the HRM (Theory Y).
- An individual in the position of power, driving policies and
processes , has evolved into team based collaborative management
methods.
- A new generation of leadership skills, styles and methods has
evolved.
- New work methods and newer ways to managing people and
processes are evolving.
2.Globalization and Jobs:
The globalization resulted into loss of jobs or created additional jobs.
The liberalization and globalization has created an enabling
environment for cutting down regular, salaried jobs through
VRS,Contractual employment and outsourcing. In developing countries
36
globalization adds to employment.

Globalization and Its Impact

3.Globalization and Wages:
-Globalization has resulted in shifting of jobs to developing
countries but shift is accompanied by disparities in wages.
-Low labor costs constitute a competitive advantage for a poor
country and attracting investment on this basis provides jobs
that can lead to greater development.
4.Globalization and Child Labor:
- Child labour is common in all the countries , rich or
poor.
Globalization affect child labour ?
-globalization results in creation of job opportunities and
enhances for earning in developing countries because of inflows
of foreign investment, or increases the value of developing
countrys export products ,this development accelerate the
reduction of child labour and enhance school enrollment
and literacy.
- As developing countries join globalization and
increasingly
37
rely on export markets to sell their products, rich countries can

Globalization and Its

Impact
5.Globalization and Women:
- Employment opportunities for women.
- Globalization has contributed to the creation of new
associations of women and strengthening of their networks
to offer mutual support and resource.
- Advance information and communications technology has
made health, micro-credit, employment and information
more accessible to women.
6.Globalization and Inequalities:
International business has resulted in inequalities of income
within nations, between nations and globally. A heavy
concentration of wealth and income will provide richer
individuals with sufficient resources to offer bribes to high
ranking officials and policy makers.
7.Globalization and Developing Countries:
The globalization does not benefitted all countries
equally.
38

Globalization and Its

Impact on
I. Globalization and its impact on
people at social, cultural, and
psychological levels:
Globalization is associated with rapid and significant
human changes. The movements of people from rural
to urban areas has accelerated, and the growth of cities
in the developing world especially is linked to
substandard living for many. Family disruption and
social and domestic violence are increasing. Concepts
of national identity, and of family, job and tradition are
changing rapidly and significantly. There is concern that
competitiveness introduced by globalization is leading
to more individualistic societies.
39

Globalization and Its

Impact
II. The globalization has positive impact on
- Economic growth, (GDP 2.29% open
industrialized world, open trade policies
increased 4.49 compared to closed trade
policies developing countries)
- labor markets (improved working hours &
other comforts of life) ,
- incomes, living standard, life
expectancy, child mortality rate,
- macro and micro economic policies which
the different governments are pursuing.
40
(Bourdeaux 2008, Gwartney & Lawson
2001)

Globalization and Its

Impact
III. In 1990 Kenichi Ohame observed the 5 cs of a firms environment
influenced by globalization influenced by globalization:
1. Customer: Globalization advocates free capitalist economy where
customer is the king. Firms socialization should have customers focus.
2. Competition: In global economy , the firms tend to strengthen their
competitive positions through strategic alliances and joint ventures, which
helps to minimized risk and uncertainty and improves profitability and
marketability.
3. Company: Companys success depends on commitment to globalization
by pulling all its effects in enhancing its efficiency & competitive edge for
a better performance.
4. Currency: International finance scenario is changing dynamically. The
global firms have to meet the challenge of remaining currency netural in
pricing ,product and supply procurement as well as human resource
planning and knowledge development.
5. Country: The focus of globalization propels development of global
location of products through horizontal and vertical integration of FDI.
Successful globalization is based on the market development system
rested on integrated different geographical /locational bases of
production.
41

Globalization & India

India Went Through Economic Reforms From
1991.
The major ones are:
Reductions In Import Duty
Removal of restrictions on imports
Devaluation of Currency
Removal of permissions on setting up
enterprises and expansion of capacity
Removal of permission of Controller of Capital
on Share Premium Account on issues of Shares
Privatization of Public Sector Units
Membership of WTO
Easier entry of multinationals
42

Globalization of the World Economy: Recent Trends

Emergence of Globalized
Financial Markets
Trade Liberalization and
Economic Integration
Privatization

43

Emergence of Globalized
Financial Markets
Deregulation of Financial Markets
coupled with
Advances in Technology
have greatly reduced information and
transactions costs, which has led to:
Financial Innovations, such as
Currency futures and options
Multi-currency bonds
Cross-border stock listings
International mutual funds
44

Economic Integration
Over the past 50 years,
international trade increased
about twice as fast as world GDP.
There has been a sea change in
the attitudes of many of the
worlds governments who have
abandoned mercantilist views
and embraced free trade as the
surest route to prosperity for
45

Liberalization of Protectionist
Legislation
The General Agreement on Tariffs and
Trade (GATT) a multilateral agreement
among member countries has reduced
many barriers to trade.
The World Trade Organization has the
power to enforce the rules of
international trade.
The North American Free Trade
Agreement (NAFTA) calls for phasing out
impediments to trade between Canada,
Mexico and the United States over a 1546

Privatization
The selling off state-run enterprises to
investors is also known as
Denationalization.
Often seen in socialist economies in
transition to market economies.
By most estimates this increases the
efficiency of the enterprise.
Often spurs a tremendous increase in
cross-border investment.
47

 WTO AND ITS

IMPACT

48

Global-Level Cooperation
Among Nations
The World Trade Organization (WTO), the
World Bank, and the International
Monetary Fund (IMF) are three
fundamental institutions affecting global
cooperation of nations.
The IMF and World Bank serve as a
financial base for cooperation.
The WTO serves as the institutional
foundation of the world trading system.
49

WORLD TRADE ORGANIZATION

What is the WTO?
The World Trade Organization (WTO) is multilateral
trade organization aimed at international trade
liberalization.
The organization officially commenced on January
1, 1995 under the Marrakech Agreement , replacing
the General Agreement on Tariffs & Trade (GATT),
which commenced in 1948.
WTO has 157 Members. representing more than
97% of the world's population, and 26 observers,
most seeking membership. The WTO is governed
by a ministerial conference, meeting every two
years; a general council, which implements the
conference's policy decisions and is responsible
for
50

The World Trade Organization (WTO)

Exhibit :Multilateral negotiations under GATT

Doha Round

2002-

149

--

51

WORLD TRADE ORGANIZATION

The WTO's headquarters is at the Centre William Rappard,
Geneva, Switzerland.
The World Trade Organization (WTO) is the only global
international organization dealing with the rules of trade
between nations.
The goal is to help producers of goods and services,
exporters, and importers conduct their business
WTO deals with regulation of trade between participating
countries; it provides a framework for negotiating and
formalizing trade agreements, and a dispute resolution
process aimed at enforcing participants' adherence to
WTO agreements which are signed by representatives of
member governments and ratified by their parliaments.
There are a number of ways of looking at the World Trade
Organization. It is an organization for trade opening. It is a
forum for governments to negotiate trade 52
agreements. It

The World Trade Organization

(WTO)
WTO Functions:

Reduce import duties.

Eliminate trade discrimination through most favored
nation (treating everyone equally) and national
treatments (where all products are considered
domestic once they cross national borders).
Combat protection and trade barriers
-Dumping the sale of imported goods either at prices below
what a company charges in home market or below cost

Provide forums for dealing with trade issues.

Provide dispute resolution services for members.
Administering WTO trade agreements.
Monitoring & Reviewing national trade policies.
Technical assistance and training for developing
countries
Cooperation with other international
53
organizationslike IMF,WB to achieve greater

The World Trade

Organization (WTO)
Bilateral and regional customs unions
and common markets.
Lowered tariffs to developing nations
without violating antidiscrimination
rules.
Establishment of a Generalized
System of Preferences for developing
nations.
Escape clauses, so that new
members can protect infant
54

WORLD BANK
or
THE INTERNATIONAL
BANK FOR
RECONSTRUCTION &
DEVELOPMENT
(IBRD)
ROLE OF WORLD BANK
55

THE WORLD BANK

The International Bank for Reconstruction &
Development (IBRD or World Bank) was established by
the International Economic Conference at Bretton
Woods in July 1944 and started functioning in June
1946.
The World Bank is an International organization that
provides loans to developing countries aimed toward
poverty reduction & economic development.
World Bank is not a bank in the common sense. It is
one of United Nations specialized agencies , made up
of 184 member countries. These countries are jointly
responsible for how the institution is financed and how
its money is spent.
The size of a countrys shareholding is determined by
the size of countrys economy relative to56the world
economy.

THE WORLD BANK

The world bank group Made up of 5 different organizations:
International Bank for Reconstruction and Development
(IBRD):
International Development Association (IDA):
- IBRD and IDA provide low cost loans & grants to
developing countries.
International Finance Corporation (IFC):
- provides equity, long term loans, loan guarantees &
advisory services to developing countries that would have
limited access to capital.
Multilateral Investment Guarantee Agency (MIGA):
- encourages foreign investment in developing countries
by providing guarantees to foreign investors against
losses caused by war, civil disturbance etc.
International Center for the Settlement of Investment
Disputes (ICSID):
57

Role of World Bank

The World Bank is an international financial
institution that provides loans to developing
countries for capital programmes.
The World Bank is one of five institutions
created at the Bretton Woods Conference in
1944.
The International Monetary Fund , a related
institution, is the second. Delegates from many
countries attended the Bretton Woods
Conference. The most powerful countries in
attendance were the United States and United
Kingdom, which dominated negotiations.
Although both are based in Washington D.C.,
58
the World Bank is, by custom, headed by an

Role of World Bank

The World Bank's official goal is the reduction of
poverty. By law, all of its decisions must be
guided by a commitment to promote foreign
investment international trade and facilitate
capital investment.
The World Bank differs from the World Bank
Group, in that the World Bank comprises only
two institutions: the International Bank fo
reconstruction and Development (IBRD) and the
International Development Association (IDA),
whereas the latter incorporates these two in
addition to three more: International Finance
59
Corporation (IFC), Multilateral Investment

ROLE OF
IMF
60

The International Monetary

Fund (IMF)

Set up in 1944 at the Bretton Woods

Conference, New Hampshire
Set up to help put in place an economic
structure that would help prevent
the problems experienced by many
countries
in the 1930s
Aims to stabilise the international
monetary system and help when
monetary flow
from trade causes problems
Provides help and advice as well as funds
61

The Operation of the IMF

IMF is an international financial organization
comprised of 184 member countries. The
Headquarter is in Washington DC. IMF is
thought of as a bank for the central bank of
member nation.
Purposes, as stipulated in its Articles of
Agreement, are to
Promote international monetary cooperation
Facilitate the expansion of international trade
Promote exchange stability and a multilateral
system of payments
Make temporary financial resources available
to members under adequate safeguards
62

The Operation of the IMF

Major decision-making body is its Board of
Governors -Each member appoints a
Governor and an Alternate Governor
Day-to-day business rests in the hands of
Executive Board -Composed of 22
Executive Directors plus Managing Director
Six of the 22 Executive Directors are appointed by
largest IMF quota holders
Remainder elected by groups of member countries
not entitled to appoint Executive Directors
Managing Director is appointed by Executive
Board and is traditionally European (often French)
Chairs Executive Board and conducts IMFs
business
63
Currently three Deputy Managing Directors

Administrative Structure of
the IMF

64

IMF Work
The IMF's fundamental mission is to help ensure stability in the international
system. It does so in three ways: keeping track of the global economy and
the economies of member countries; lending to countries with balance of
payments difficulties; and giving practical help to members.

Surveillance:

The IMF oversees the international monetary system and monitors the
financial and economic policies of its members. It keeps track of economic
developments on a national, regional, and global basis, consulting
regularly with member countries and providing them with macroeconomic
and financial policy advice.

Technical Assistance:
To assist mainly low- and middle-income countries in effectively managing
their economies, the IMF provides practical guidance and training on how
to upgrade institutions, and design appropriate macroeconomic, financial,
and structural policies.

Lending:

The IMF provides loans to countries that have trouble meeting their
international payments and cannot otherwise find sufficient financing on
affordable terms. This financial assistance is designed to help countries
restore macroeconomic stability by rebuilding their international
reserves,
65
stabilizing their currencies, and paying for importsall necessary

The Operation of the IMF

Most important feature of IMF is its
quota system
Determine both the amount members can
borrow from the IMF and their relative voting
power
Higher a members quota, the more it can borrow
and the greater its voting power

Members quotas are their

subscriptions to the IMF
Based on their relative sizes in the world
economy
Pays one fourth of its quota in widely66
accepted reserve currencies (US dollar,

The Operation of the IMF

The IMF engages in four areas
of activity
Economic surveillance or
monitoring
Dispensing of policy advice
Lending
Perhaps most important

Technical assistance
67

Tranche

(i.e. share, % or portion of

money)

If an IFM member faces balance of

payments difficulties
Can automatically borrow one fourth of its
quota in the form of a reserve tranche
When the IMF lends to a member country,
what actually happens is domestic country
purchases international reserves from the
IMF using its own domestic currency
reserves
Member country is then obliged to repay IMF by
repurchasing its own domestic currency reserves
with international reserve assets
IMF lending is known as a purchase-repurchase
68

Tranche
Credit tranches

Originally, each were equal to of the

members quotas
In the late 1970s, credit tranches were
increased to 37.5% of quota
First credit tranche is more or less automatic
Second through fourth credit tranches require
that the member adopt policies
(conditionality) that will solve balance of
payments problem at hand
Effectively limits a member countrys credit to 150
percent of its quota
As IMF evolved, it created a number of special credit
facilities that extend potential credit beyond 150% level

Drawings on IMF by its members have to

be repaid
69

Figure

IMF Lending

70

Table
Special Credit
Facilities

71

Ideal Role of the IMF

Development of a country requires
an inflow of private foreign savings
Inflow would cover a current account
deficit often caused by import of
capital goods
Occasionally, this private foreign
savings disappears
Resulting in a balance of payments
crisis
In these instances IMF steps in
Member draws on its reserve and credit
72
tranches

Responsibilities of IMF
Promoting

international monetary
cooperation.
Facilitating the expansion and balanced
growth of international trade.
Promoting exchange stability.
Assisting in the establishment of a
multilateral system of payments and
Making its resources available (under
adequate safeguards) to members
experiencing balance of payments
73

History of IMF Operations

1950s-1960s
In its initial years, the IMF was nearly irrelevant
However, Suez crisis of 1956 forced Britain to draw
on its reserve and first credit tranches
Japan drew on its reserve tranche in 1957
Between late 1956 through 1958 IMF was involved in
policies that lead to the convertibility of both British
pound and French franc
Concerned about the United States ability to defend
the dollar and other major industrialized countries
abilities to maintain their parities
IMF introduced the General Arrangements to Borrow (GAB)
in October 1962
Involved the central banks of ten countries setting aside a $6
billion pool to maintain stability of Bretton Woods system
Countries involved became known as Group of Ten or G-10 and
comprised a rich countries club
74

History of IMF OperationsMid-toLate 1960s

By 1965, US faced two unappealing options

Reduce world supply of dollars to enhance
international confidence by reducing
international liquidity
Expand world supply of dollars to enhance
international liquidity by reducing
international confidence
But where was the world to turn for a
reserve asset?
1964 and 1968 annual meetings of IMF
resulted in creation of a new reserve
asset to supplement both gold and
75
dollar

History of IMF OperationsSpecial

Drawing Rights, 1970s
Came into being in July 1969
In 1971, when United States broke
gold-dollar link, the SDR was redefined
in terms of a basket of five currencies
dollar, pound, mark, yen, and franc
Allocated in proportion to members
quotas
Never played the important role
envisaged for them
Perhaps best seen as one of many
attempts to resolve Triffin dilemma
76

History of IMF Operations,

1970s

Oil price increases of 1973-1974 caused substantial

balance of payments difficulties for many countries
of the world
In June 1974, the IMF established an oil facility to
assist these countries
Acted as an intermediary, borrowing funds from
oil producing countries and lending them to oil
importing countries
A second oil facility was established in 1975
Slightly more strict than the first
During this time, a bias towards private-sector
lending helped to prevent sufficient increases in
IMF quotas
Given the limits of the quota system, IMF was
77
becoming more of a financial intermediaryless

History of IMF Operations, 1970s1980s

In 1976, IMF began to sound warnings about
sustainability of developing-country borrowing
from commercial banking system
Banking system reacted with hostility to
these warnings
Argued Fund had no place interfering with
private transactions
The 1980s began with a significant increase in
real interest rates and a significant decline in
non-oil commodity prices
Increased cost of borrowing and reduced
export revenues
78

History of IMF Operations1980s

In 1982, IMF calculated that US banking
system outstanding loans to Latin America
represented approximately 100% of total
bank capital
In August 1982 Mexico announced it would
stop servicing its foreign currency debt
At the end of the month, Mexican
government nationalized its banking
system
1982 also found debt crises beginning in
Argentina and Brazil
Argentina: Overvalued exchange rate,
used as a nominal anchor to curb
inflationary expenditures
Brazil: Rates of devaluation did not keep
79

History of IMF Operations,

1980s

International commercial banks began to withdraw

credit from many of the developing countries of the
world
Debt crisis became global
Within a few years of outbreak phenomenon of
net capital outflows appeared
Involved capital account payments of debtor
countries exceeding capital account receipts
By second half of 1980s, some debt was trading at
discounts in secondary markets
In 1989, US Treasury Secretary Nicholas Brady
proposed a plan in which IMF and World Bank
lending could be used by developing countries to
buy back discounted debt
Amounted to partial and long-needed debt
forgiveness, were approved by the IMF and
became known as the Brady Plan80

History of IMF Operations,

1990s

Starting in the 1990s, private, non-bank

capital began to flow to developing
countries in the form of both direct and
portfolio investment
Number of highly-indebted countries began
to show increasing unpaid IMF obligations
In November 1992, a Third Amendment to
the Articles of Agreement allowed for
suspension of voting rights in the face of
large, unpaid obligations
Mexico underwent a second crisis in late
1994 and early 1995
IMF was unable to respond effectively
US Treasury assembled a loan package
81

History of IMF Operations,

1990s

In 1997-1998, crises struck a number of Asian countries

most notably Thailand, Indonesia, South Korea, and
Malaysia and also Russia
Resulted in sharp depreciations of the currencies
In the cases of Thailand, Indonesia, and South Korea,
IMF played substantial and controversial roles in
addressing crises
Loan packages were designed with accompanying
conditionality agreements
Supplementary Reserve Facility was introduced to
provide large volumes of high-interest, short-term
loans to selected Asian countries
In October and November 1998, IMF put together
a package to support Brazilian currency, the real
Attempt to prevent Asian and Russian crises
from spreading to Latin America 82

History of IMF Operations,

1990s
Recent years have witnessed important changes at

the IMF
In 1997 General Agreement to Borrow was
supplemented by the New Arrangement to
Borrow
Involves 25 IMF members agreeing to lend up
to US$46 billion to IMF in instances where
quotas prove to be insufficient
In 1999, a new lending facility was added
Poverty Reduction and Growth Facility was
created to replace the 1987 Enhanced
Structural Adjustment Facility
Represents beginning of an attempt to
integrate poverty reduction consideration
into macroeconomic policy formation of IMF
83
In 1999, quotas were increased by 45% to a total

History of IMF Operations,

2000s
The expansion of the IMFs membership,

together with the changes in the world

economy, have required the IMF to adapt in a
variety of ways to continue serving its purposes
effectively.
In 2008, faced with a shortfall in revenue, the
International Monetary Funds executive board
agreed to sell part of the IMFs gold reserves.
On April 27, 2008, former IMF Managing
Director Dominique Strauss-Kahn welcomed the
boards decision of April 7, 2008, to propose a
new framework for the fund, designed to close
a projected $400 million budget deficit over the
84
next few years. The budget proposal
includes

History of IMF Operations ,

2000s
At the 2009 G-20 London summit, it was decided
that the IMF would require additional financial
resources to meet prospective needs of its member
countries during the ongoing global financial crisis.
As part of that decision, the G-20 leaders pledged
to increase the IMFs supplemental cash tenfold to
$500 billion, and to allocate to member countries
another $250 billion via Special Drawing Rights.
[13][14]

On October 23, 2010, the ministers of finance of G20, governing most of the IMF member quotas,
agreed to reform IMF and shift about 6 percent of
the voting shares to major developing nations and
countries with emerging markets.
85
As of August 2010, Romania ($13.9 billion),
Ukraine

 The Monetary
System

86

Evolution of the
International Monetary
System
Bimetallism: Before 1875
Classical Gold Standard: 18751914
Interwar Period: 1915-1944
Bretton Woods System: 19451972
The Flexible Exchange Rate
87

The Monetary System

Bimetallism: Before 1875
Free coinage was maintained for both gold and
silver.
A double standard in the sense that both gold
and silver were used as money.
Some countries were on the gold standard,
some on the silver standard, some on both.
Both gold and silver were used as international
means of payment and the exchange rates
among currencies were determined by either
their gold or silver contents.
Greshams Law: Only the abundant metal was
used as money, diving more scarce metals out
88
of circulation

The Monetary System

Classic gold standard: 1875-1914

1. Great Britain introduced full-fledged gold standard in 1821,

France (effectively) in the 1850s, Germany in 1875, the US in
1879, Russia and Japan in 1897.
2. Gold alone is assured of unrestricted coinage
3. There is a two-way convertibility between gold and national
currencies at a stable ratio
4. Gold may be freely exported and imported
5. Cross-border flow of gold will help correct misalignment of
exchange rates and will also regulate balance of payments.
6. The gold standard provided a 40 year period of unprecedented
stability of exchange rates which served to promote
international trade.
There are shortcomings:
. The supply of newly minted gold is so restricted that the
growth of world trade and investment can be hampered for
the lack of sufficient monetary reserves.
. Even if the world returned to a gold standard, any national
government could abandon the standard. 89

The Monetary System

Interwar period: 1915-1944
World War I ended the classical gold
standard in 1914
Trade in gold broke down
After the war, many countries suffered
hyper inflation
Countries started to cheat (sterilization
of gold)
Predatory devaluations (recovery through
exports!)
The US, Great Britain, Switzerland, France
and the Scandinavian countries restored
the gold standard in the 1920s.
90

The Monetary System

Bretton Woods system: 1945-1972
Named for a 1944 meeting of 44 nations at
Bretton Woods, New Hampshire.
The purpose was to design a postwar
international monetary system.
The goal was exchange rate stability without
the gold standard.
The result was the creation of the IMF and the
World Bank.
U.S. dollar was pegged to gold at $35.00/oz.
Other major currencies established par
values against the dollar. Deviations
of
91

The Monetary System

Jamaica Agreement (1976)

Central banks were allowed to intervene in the

foreign exchange markets to iron out unwarranted
volatilities.
Gold was officially abandoned as an international
reserve asset. Half of the IMFs gold holdings were
returned to the members and the other half were
sold, with proceeds used to help poor nations.
Non-oil exporting countries and less-developed
countries were given greater access to IMF funds.

Plaza Accord (1985)

G-5 countries (France, Japan, Germany, the U.K., and

the U.S.) agreed that it would be desirable for the
U.S. dollar to depreciate.

Louvre Accord (1987)

G-7 countries (Canada and Italy were added) would

92 rate stability.
cooperate to achieve greater exchange

The Monetary System

The Flexible Exchange Rate Regime:

1973-Present :

Flexible exchange rates were declared

acceptable to the IMF members.
Central banks were allowed to
intervene in the exchange rate
markets to iron out unwarranted
volatilities.
Gold was abandoned as an international
reserve asset.
93

Current Exchange Rate

Arrangements

36 major currencies, such as the U.S. dollar, the

Japanese yen, the Euro, and the British pound
are determined largely by market forces.
50 countries, including the China, India, Russia,
and Singapore, adopt some forms of Managed
Floating system.
41 countries do not have their own national
currencies!
40 countries, including many islands in the
Caribbean, many African nations, UAE and
Venezuela, do have their own currencies, but
they maintain a peg to another currency such
94
as the U.S. dollar.

Current Exchange Rate

Arrangements
Free Float

The largest number of countries, about 48,

allow market forces to determine their
currencys value.

Managed Float
About 25 countries combine government
intervention with market forces to set
exchange rates.

Pegged to another currency

Such as the U.S. dollar or euro (through franc
or mark).

No national currency
95
Some countries do not bother printing
their

European Monetary
System

Eleven European countries maintain

exchange rates among their currencies
within narrow bands, and jointly float
against outside currencies.
Objectives:
To establish a zone of monetary
stability in Europe.
To coordinate exchange rate policies
vis--vis non-European currencies.
To pave the way for the European
Monetary Union.
96

The Euro
What is the euro?
When will the new European
currency become a reality?
What value do various national
currencies have in euro?

97

What Is the Euro?

The euro is the single currency of the
European Monetary Union which was
adopted by 11 Member States on 1
January 1999.
These member states are: Belgium,
Germany, Spain, France, Ireland,
Italy, Luxemburg, Finland, Austria,
Portugal and the Netherlands.
98

EURO CONVERSION RATES

1 Euro is Equal to:
40.3399 BEF

Belgian franc

1.95583 DEM

German mark

166.386 ESP

Spanish peseta

6.55957 FRF

French franc

67.10 INR

Indian rupee

1936.27 ITL

Italian lira

40.3399 LUF

Luxembourg franc

2.20371 NLG

Dutch gilder

13.7603 ATS

Austrian schilling

200.482 PTE

Portuguese escudo

5.94573 FIM

Finnish markka

99

What is the subdivision of the

euro?
During the transitional period up to 31
December 2001, the national
currencies of the member states (Lira,
Deutsche Mark, Peseta, Franc. . . ) will
be "non-decimal" subdivisions of the
euro.
The euro itself is divided into 100
cents.

100

What is the official sign of

the euro?
The

sign for the new single currency

looks like an E with two clearly
marked, horizontal parallel lines across
it.

It was inspired by the Greek letter epsilon, in

reference to the cradle of European civilization
and to the first letter of the word 'Europe'.
101

What are the different

denominations of the euro
notes and coins ?
There will be 7 euro notes and 8
euro coins.
The notes will be: 500, 200, 100,
50, 20, 10, and 5 euro.
The coins will be: 2 euro, 1 euro,
50 euro cent, 20 euro cent, 10,
euro cent, 5 euro cent, 2 euro
cent, and 1 euro cent.
102

How will the euro affect

contracts denominated in
national currency?

All insurance and other legal contracts

will continue in force with the substitution
of amounts denominated in national
currencies with their equivalents in euro.
Euro values will be calculated according
to the fixed conversion rates with the
national currency unit adopted on 1
January 1999.
Generally, the conversion to the euro will
take place on 1 January 2002, unless both
103

The Mexican Peso Crisis

On 20 December, 1994, the Mexican
government announced a plan to
devalue the peso against the dollar
by 14 percent.
This decision changed currency
traders expectations about the
future value of the peso.
They stampeded for the exits.
In their rush to get out the peso fell
by as much as 40 percent.
104

The Mexican Peso Crisis

The Mexican Peso crisis is unique in
that it represents the first serious
international financial crisis touched
off by cross-border flight of portfolio
capital.
Two lessons emerge:
It is essential to have a multinational
safety net in place to safeguard the
world financial system from such crises.
An influx of foreign capital can lead to
an overvaluation in the first place.
105

The Asian Currency Crisis

The Asian currency crisis turned out
to be far more serious than the
Mexican peso crisis in terms of the
extent of the contagion and the
severity of the resultant economic
and social costs.
Many firms with foreign currency
bonds were forced into bankruptcy.
The region experienced a deep,
widespread recession.
106

Currency Crisis
Explanations

In theory, a currencys value mirrors the

fundamental strength of its underlying
economy, relative to other economies. In
the long run.
In the short run, currency traders
expectations play a much more important
role.
In todays environment, traders and
lenders, using the most modern
communications, act by fight-or-flight
instincts. For example, if they expect
others are about to sell Brazilian reals for
107

Fixed versus Flexible

Exchange Rate Regimes
Arguments in favor of flexible
exchange rates:
Easier external adjustments.
National policy autonomy.

Arguments against flexible exchange

rates:
Exchange rate uncertainty may hamper
international trade.
No safeguards to prevent crises.
108

 Special Drawing Rights

(SDRs)
& its Role

109

Special Drawing Rights

(SDRs)
The SDR is an international reserve asset,

created by the IMF in 1969 to supplement

its member countries official reserves.
Its value is based on a basket of four key
international currencies, and SDRs can be
exchanged for freely usable currencies.
With a general SDR allocation that took
effect on August 28 and a special
allocation on September 9, 2009, the
amount of SDRs increased from SDR 21.4
billion to around SDR 204 billion
(equivalent to about $328.3 billion,
110

Introduction of SDR
The objective of IMF to introduce into payment
mechanism a new reserve asset, called Special
Drawing Rights.
In addition to the dollar and gold , that could be
transferred among participating nations in
settlement of payment deficits.
SDR are unconditional rights to draw currencies of
other nations.
SDR is called as Basket Currency because it is
based on the value of four currencies :
US dollar, European Euro, Japanese Yen & British
Pound.
SDR is the unit of account for IMF transactions and
111
is used as a unit of account for individuals like

The role of the SDR

The SDR was created by the IMF in 1969 to support the
Bretton Woods fixed exchange rate system. A country
participating in this system needed official reserves
government or central bank holdings of gold and widely
accepted foreign currenciesthat could be used to
purchase the domestic currency in foreign exchange
markets, as required to maintain its exchange rate. But
the international supply of two key reserve assetsgold
and the U.S. dollarproved inadequate for supporting
the expansion of world trade and financial development
that was taking place. Therefore, the international
community decided to create a new international
reserve asset under the auspices of the IMF.
However, only a few years later, the Bretton Woods
system collapsed and the major currencies shifted to a
112
floating exchange rate regime. In addition, the growth

The role of the SDR

The SDR is neither a currency, nor a

claim on the IMF. Rather, it is a potential

claim on the freely usable currencies of
IMF members. Holders of SDRs can obtain
these currencies in exchange for their
SDRs in two ways: first, through the
arrangement of voluntary exchanges
between members; and second, by the
IMF designating members with strong
external positions to purchase SDRs from
members with weak external positions. In
addition to its role as a supplementary
113

The role of the SDR

Basket of currencies determines the value
of the SDR
The value of the SDR was initially defined as equivalent to
0.888671 grams of fine goldwhich, at the time, was also
equivalent to one U.S. dollar. After the collapse of the Bretton
Woods system in 1973, however, the SDR was redefined as a
basket of currencies, today consisting of the euro, Japanese
yen, pound sterling, and U.S. dollar. The U.S. dollarequivalent of the SDR is posted daily on the IMFs website. It
is calculated as the sum of specific amounts of the four
basket currencies valued in U.S. dollars, on the basis of
exchange rates quoted at noon each day in the London
market.
The basket composition is reviewed every five years by the
Executive Board, or earlier if the Fund finds changed
circumstances warrant an earlier review, to ensure that it
reflects the relative importance of currencies114in the worlds

The role of the SDR

The SDR interest rate

The SDR interest rate provides the basis for calculating the
interest charged to members on regular (non-concessional)
IMF loans, the interest paid to members on their SDR
holdings and charged on their SDR allocation, and the
interest paid to members on a portion of their quota
subscriptions. The SDR interest rate is determined weekly
and is based on a weighted average of representative
interest rates on short-term debt in the money markets of
the SDR basket currencies.
SDR allocations to IMF members
Under its Articles of Agreement (Article XV, Section 1, and
Article XVIII), the IMF may allocate SDRs to member
countries in proportion to their IMF quotas. Such an
allocation provides each member with a costless,
unconditional international reserve asset on which interest is
neither earned nor paid. However, if a member's
SDR
115
holdings rise above its allocation, it earns interest on the

The role of the SDR

General allocations of SDRs have to be based on a

long-term global need to supplement existing reserve
assets. Decisions on general allocations are made for
successive basic periods of up to five years, although
general SDR allocations have been made only three times.
The first allocation was for a total amount of SDR 9.3 billion,
distributed in 1970-72, and the second allocated SDR 12.1
billion, distributed in 1979-81. These two allocations resulted
in cumulative SDR allocations of SDR 21.4 billion. To help
mitigate the effects of the financial crisis, a third general
SDR allocation of SDR 161.2 billion was made on August 28,
2009.
Separately, the Fourth Amendment to the Articles of
Agreement became effective August 10, 2009 and provided
for a special one-time allocation of SDR 21.5 billion. The
purpose of the Fourth Amendment was to enable all
members of the IMF to participate in the SDR system on an
116
equitable basis and correct for the fact that countries that

The role of the SDR

Buying and selling SDRs
IMF members often need to buy SDRs to discharge obligations to
the IMF, or they may wish to sell SDRs in order to adjust the
composition of their reserves. The IMF may act as an
intermediary between members and prescribed holders to ensure
that SDRs can be exchanged for freely usable currencies. For
more than two decades, the SDR market has functioned through
voluntary trading arrangements. Under these arrangements a
number of members and one prescribed holder have volunteered
to buy or sell SDRs within limits defined by their respective
arrangements. Following the 2009 SDR allocations, the number
and size of the voluntary arrangements has been expanded to
ensure continued liquidity of the voluntary SDR market. The
number of voluntary SDR trading arrangements now stands at
32, including 19 new arrangements since the 2009 SDR
allocations.
In the event that there is insufficient capacity under the
voluntary trading arrangements, the Fund can activate the
117
designation mechanism. Under this mechanism, members with

Scope of International
Finance
3 Areas are concerned to International
Finance .
1. International Economics:This is related to the concerned with Causes
and effects of financial flows among nations,
where application of MACROECONOMICS
comes into the scene with its Theory and
policy to the global economy.
2. International Financial Market:Concerned with HOW Individual economic
units (MNCs) cope up with the complex
financial environment of IB.
3. IF Markets:118

Use of IT in international
finance.

. Use of IT in international finance.

Information technology, in its narrow
definition, refers to the technological side
of an information system. It includes the
hardware, software, databases, networks,
and other electronic devices. It can be
viewed as a subsystem
of an information system. Sometimes,
though, the term information technology
is also used interchangeably with
information system.
119

Use of IT in international
finance.
The following examples are intended to show the diversity of

applications and the benefits provided.

information systems are being used successfully in all
functional areas of business. We provide here five
examples,
one for each of the major functional areas: accounting,
production/operations management, marketing, human
resource management, and finance.
A major role of IT is being a facilitator of organizational
activities and processes. That role will become more
important as time passes. Therefore, it is necessary that
every manager and professional staff member learn about
IT not only in his or her specialized field, but also in the
entire organization and in inter organizational settings as
well.
Information technology is a major agent of120
change,

Use of IT in international
finance.
IT Perform high-speed, high-volume, numerical computations.
Provide fast, accurate, and inexpensive communication within and
between
organizations.
Store huge amounts of information in an easy-to-access, yet small
space.
Allow quick and inexpensive access to vast amounts of information,
worldwide.
Enable communication and collaboration anywhere, any time.
Increase the effectiveness and efficiency of people working in
groups in one place
or in several locations.
Vividly present information that challenges the human mind.
Facilitate work in hazardous environments.
Automate both semiautomatic business processes and manually
done tasks.
Facilitate interpretation of vast amounts of data. 121