Financial Management in a Global Perspective

Financial Management in a Global Perspective What is Globalisation? :

Globalisation refers to the increasingly global relationships of culture, people and economic activity. Referring to economics: The global distribution of the production of goods and services, through reduction of barriers to international trade such as tariffs, export fees and import quotas. What is Global Economy?: Global economy refers to the economy, which is based on economies of all the world’s countries. You must have heard or r ead about these:-:

– 2000 – Bursting of the dot.com or technology bubble Year – – 2001 – September 11 Terrorist Attacks Year – – 2005 – The growth of China and India as world financial powers Year – – 2007 & 2008 – Sub-prime housing crisis. Year – – 2007 – 2009 – The global recession. Year – Increasing Interdependence in Global Economy:

Since the end of World War II the world has become increasingly interdependent in a number of ways. Economically the world has grown closer as financial markets, corporations and banks have all become multinational. The world’s economy is linked closely together. Changes in one region affect all others, sometimes with devastating results. Global North – North America, Western Europe, Japan and Australia are industrialised nations with high standards of living and high literacy

rate. Global South – Consists of developing nations in Asia, Africa and South America, having low literacy rates, massive unemployment, little or no

industrialisation and are economically dependent. The interdependence between the Global North and South is the primary focus of t oday’s economy. OIL – Oil prices have major impact on the world.

High prices benefits oil producing nations those in Middle East but on the other hand causes inflation in industrialised countries which are dependent on oil which leads to high prices on goods sold to non - industrialised countries which has resulted in a near constant debt crisis in most of these nations. Banking – Developed nations make loans to developing countries to help with modernisation efforts. As world economies slowed down in 1980’s many of these nations were unable to keep up with the loan payments. The IMF negotiated deals bet ween these countries for repayment.

In exchange for lower interest rates many developing nations were forced to accept free market operations. Financial Markets The financial markets of world have also become interdependent, fluctuations in market are reflected in other. Regional Cooperation Many nations have linked their economies officially by joining cooperatives or through treaties like European Union, North American American Free Trade Trade Agreement Agreement etc. Recent Trends in International Trade :

65% of EU merchandise exports went to EU countries. 12% of African merchandise exports went to African countries. Two third of the total world export went to Europe and Asia Export of world commercial services up by 9% Asia’s commercial services export up by 22% Source:- WTO Report 2011     

Following are the benefits to those countries having unrestricted foreign trade::     

Increases the access of their producers to larger, international markets, Creates an opportunity to benefit from the international division of labour, Increases the quality of output in the context of global competition, Facilitates specialisation due to presence of foreign competition, Provides high quality products to the customers.

Recent developments in Global Financial Markets::     

Liberalization Integration Innovation Establishment of International Organizations’ Advent of the Euro (€)

Liberalization and Global Financial Markets:

– – It refers to a relaxation of previous government restrictions usually in areas of social or economic policy. Liberalization

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Economic Li beralization beralization – – It refers to fewer government regulations and restrictions in the economy in exchange for greater participation of private entities. entities. In short short it refers refers to the removal removal of controls controls to encourage encourage economic economic developme development. nt.

Effect of Liberalization on developing countries: 

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World bank has reported that per capita real income grew nearly three times faster for the developing countries that lowered trade barriers than than for other developing developing countries. Another study finds that global poverty rates have declined significantly over the last three decades, estimating between 250 million and 500 million fewer poor in 2000 than in 1970 China, for example, has aggressively opened it’s market and expanded it’s trade, lifting more than 250 million people out of the poverty. Chile which also active ly opened it’s market, has more than halved it’s poverty rate from 46% in 1987 to 18% in 2004. Helps in the development of the countries. Has led to removal of restrictions on pricing of various financial assets, which is one of the pre-requisites for market integration.

Advantages of Liberalisation :

1. 2. 3. 4. 5. 6.

Increased Production Production Efficiencies Benefits to Consumers Foreign Exchange Gains Employment Economic Growth

Disadvantages of Liberalisation:

1. 2. 3. 4. 5. 6.

Structural unemployment may occur in the short term Increases domestic economic instability from international trade cycles, as economies become dependent on global markets International markets are not a level playing field New industries industries may find find it difficult difficult to become become established established in a competit competitive ive environment environment Free trade can lead to pollution and other environmental problems Pressure to increase protection during global financial crisis

Integration and Global Financial Markets : Integration – – Integration of financial markets is a process of unifying markets and enabling convergence of risk adjusted returns on the assets of

similar maturity across the markets. Financial markets all over the world have witnessed growing integration within as well as across boundaries, spurred by deregulation, globalisation and advances in information technology. Benefits of Integration : Consumption Smoothing : Access to world capital markets may allow a country to engage in risk sharing and consumption  

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smoothing, by allowing the country to borrow in bad times and lend in good times. Domestic Investment and Growth : The ability to draw upon the international pool of resources that financial openness gives access to may also affect domestic investment and growth. Enhanced macroeconomic discipline: It has been argued that by increasing the rewards of good policies and the penalties for bad ones, the free flow of capital across the borders may induce countries to follow more disciplined macroeconomic policies and thus reduce the frequency of policy mistakes. Increased banking system efficiency and financial stability: Another argument in favour of financial integration is that it may increase the depth and breadth of domestic financial markets and lead to an increase in the degree of efficiency of the financial intermediation process, by lowering lowering cost cost and excessive excessive profits associated associated with with monopolised monopolised or cartelised cartelised markets markets

Potential Costs : Potential Costs Concentration of capital flows and lack of access: There is an ample historical evidence that periods of “surge” in 

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cross border capital flows tend to be highly concentrated to a small number of recipient countries. Number of developing countries specially small ones may simply be rationed out world capital markets – regardless of how open their capital account is. Domestic misallocation of capital flows: The impact of investments on long term growth may be limited if they are used to finance speculative or low quality domestic investments. Loss of macroeconomic stability : The large capital inflows can have undesirable macroeconomic effects, including rapid monetary expansion, inflationary pressures, real exchange rate appreciation and widening current account deficits. Pro-cyclicality of short-term flows: Small developing economies are often rationed out of world capital markets. Moreover, among those countries with a greater potential to access these markets( such as oil producers), the availability of resources may be asymmetric. They may able to borrow in good times but in bad times they may face constraints. Herding, contagion and volatility of capital flows : A high degree of financial openness may be conducive to high degree of volatility in capital movements, which may lead to reversals in short-term flows associated with speculative pressures on domestic currency Entry of foreign banks: It may lead to higher degree of credit rationing to small firms leading to adverse effect on output,



Innovation and Global Financial Management : Innovation: Innovation is the creation of better or more effective products, processes, services, technologies, or ideas that are accepted by

markets, government and society Financial Innovation : It refers to the creating and marketing of new type of securities. Innovations in international financial markets arise when

firms, usually financial institutions, find it profitable to offer or employ a technique or instrument which better fulfills one of the four functions provided by the international international financial financial sector: sector: 1. Liquid and standardized instruments for effecting payments in individual currencies 2. Mechanism for conducting monetary exchange between different currencies 3. Institutions and markets for channeling saving into investments across national boundaries; and 4. Mechanisms for allocating, diversifying and compensating of risk Example – Different types of derivatives and securitisation of debt. Advantages of Financial Innovation:

1. 2. 3. 4. 5.

Moving funds across time and space Pooling of funds Managing Risk Extracting information to support decision making Availability of larger funds and at lower costs

Disadvantages of Financial Innovation :

1. 2.

Investors could find themselves holding assets whose risk – return profile turns out to be different from what they believed Borrowers may find a sudden fall on credit availability.

Establishment of International Organisations : General Agreement of Tariff and Trade (1947)

It is an international organisation set up for liberalising trade and reducing trade barriers. Last meeting held at Uruguay started in 1986 ended in 1994. This meeting was attended by 117 countries and they have agreed to reduce the trade barriers, tariff by 38% and so on. World Trade Organisation (WTO) – 1995

It was established to replace GATT and to enforce rules and resolve trade disputes between member countries. Currently it has 146 members and headquarter at Geneva and accou nts for 97% of the world’s trade. Regional Trade Agreements:

1. 2.

European Union: With 22 member countries, has eliminated barriers to the free flow of goods, capital and people through out Europe, now with a single currency in member countries. North Americ American Free Trade Agreement (NAFTA): It was signed in 1994. Established to create a “free trade area” in Canada, US and Mexico.

Advent of the Euro: “€” It is the official currency of the Eurozone: 17 out of 27 member states of E uropean union. Started trading in 1999 the euro is the second

largest reserve currency and as well as second most traded currency in the world after US$. Monetary policy is now conducted by the European Central Bank in Frankfurt, modelled after the German Central Bank. Benefits of the Euro:

1. 2. 3. 4. 5.

It eliminates foreign exchange risk Leads to reduction in transaction cost New funding and investment investment possibilities possibilities will will become more efficient efficient and competitive competitive Financing costs of the firm will scale down as a result of transparency and competition Will lead to a significant increase in trade and investment within the euro zone

Risks associated with Euro:

1. 2. 3. 4.

Different economies of euro zone are at different levels of economic cycle, and single monetary policy may appear inadequate for all the countries. Absence of seignorage sharing and open market operations. Volatility of euro in terms of $ There are only assumptions about reduction in transaction cost but to the extent it will get translated into efficiency is a doubt.

Challenges of International Financial Management :

Managers of the international firms have to understand the environment in which they function if they are to achieve their objective in maximising the value of their firms, or the rate of return of foreign operations. The environment consists of:



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The foreign country’s environment, consisting of such aspects as t he political and socioeconomic systems, a nd people’s cultur al values and aspirations. Understanding of the host country’s environment is c rucial for successful operation and essential for the assessment of the political risk.

Besides understanding the environment there are some more challenges which arises out of international financial management: 1. Multiplicity and complexity of taxation systems. 2. Manager has to worry about the foreign exchange and political risks in positioning funds and in mobilizing cash resources

Liberalization refers to a relaxation of previous government restrictions, usually in areas of social or economic policy. In some contexts this process or concept concept is often, often, but not always, always, referred referred to as deregulation. deregulation. Liberalization Liberalization of autocratic autocratic regimes regimes may may precede precede democratization democratization (or (or not, as in the case of the Prague Spring). In the arena of social policy it may refer to a relaxation of laws restricting for example divorce, abortion, or drugs and to the elimination of laws prohibiting same-sex same-sex sexual sexual relations relations or same-sex same-sex marriage. marriage. Most often, the term is used to refer to economic liberalization, especially trade liberalization or capital market liberalization. Although economic liberalization is often associated with privatization, the two can be quite separate processes. For example, the European Union has liberalized gas and electricity markets, instituting a system of competition; but some of the leading European energy companies (such as EDF and Vattenfall) remain partially or completely in government ownership. Liberalized and privatized public services may be dominated by just a few big companies particularly in sectors with high capital costs, or high such as water, gas and electricity. In some cases they may remain legal monopoly at least for some part of the market (e.g. small consumers). Liberalization is one of three focal points (the others being privatization and stabilization) of the Washington Consensus's trinity strategy for economies in transition. An example of Liberalization is the "Washington Consensus" which was a set of policies created and used by Argentina There is also a concept of hybrid liberalisation as, for instance, in Ghana where cocoa crop can be sold to a variety of competing private companies, but there is a minimum price for which it can be sold and all exports are controlled by the state

Balance of payments: Balance of payment is the record of the economic and financial flows that take place over a specified time period between residents residents and non-residents non-residents of a given country. country. Balance Balance of payments payments (BOP) accounts accounts are an an accounting accounting record of all monetary monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The BOP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items. When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counter-balanced in other ways – such as by funds earned from its foreign investments, by running down central bank reserves or by receiving loans from other countries. While the overall BOP accounts will always balance when all types of payments are included, imbalances are possible on individual elements of the BOP, such as the current account, the capital account excluding the central bank's reserve account, or the sum of the two. Imbalances in the latter sum can result in surplus countries accumulating wealth, while deficit nations become increasingly indebted. The term "balance of payments" often often refers refers to this sum: a country's balance balance of payments payments is said said to be in surplus surplus (equivalently, (equivalently, the balance of of payments is positive) positive) by a certain amount if sources of funds (such as export goods sold and bonds sold) exceed uses of funds (such as paying for imported goods and paying for foreign foreign bonds purchased) by that amount. amount. There There is said to be a balance balance of payments payments deficit deficit (the balance balance of payments payments is said to be negative) if the former are less than the latter. Under a fixed exchange rate system, the central bank accommodates those flows by buying up any net inflow of funds into the country or by providing foreign foreign currency currency funds to the foreign exchange exchange market market to match match any internationa internationall outflow of funds, thus preventing preventing the funds flows from affecting the exchange rate between the country's currency and other currencies. Then the net change per year in the central bank's foreign exchange reserves is sometimes called the balance of payments surplus or deficit. Alternatives to a fixed exchange rate system include a managed float where some changes of exchange rates are allowed, or at the other extreme a purely floating exchange rate (also known as a purely flexible exchange rate). With a pure float the central bank does not intervene at all to protect or devalue its currency, allowing the rate to be set by the



A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. Uses:

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Balance of payments may be used as an indicator of economic and political stability. For example, if a country has a consistently positive BOP, BOP, this could mean that that there is significant foreign investment investment within within that country. country. It may may also mean mean that the country country does not export much of its currency. This is just another economic indicator of a country's relative value and, along with all other indicators, should be used with caution. The BOP includes the trade balance, foreign investments and investments by foreigners.

International monetary systems : International monetary systems are sets of internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border investment and generally the reallocation of capital between nation states. They provide means of payment acceptable between buyers and sellers of different nationality, including deferred payment. To operate successfully, they need to inspire confidence, to provide sufficient liquidity for fluctuating levels of trade and to provide means by which global imbalances can be corrected. The systems can grow organically as the collective result of numerous individual agreements between international economic actors spread over several decades. Alternatively, they can arise from a single architectural vision as happened at Bretton Woods in 1944. ding nations about exchange rates and the possible conversion of currencies.such an arrangement is called the international monetary systemit is a part of the international financial system. ross bordersconversion of national currenciesacquisition/liquidation of financial assets across borders, andinternational credit creationit is multilateral in nature 

International Monetary System

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Currency exchange rates depend on the structure of the international monetary system

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In 2003 of all IMF members currencies – Only 19% were free floating – 25% were managed float – 8% were adjustable peg – 22% were fixed peg – 4% were fixed by a currency board – 22% were not currency of their own (use Euro, US Dollar)

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Evolution of the International Monetary System

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Gold Standard: currencies pegged to gold value – Convertibility guaranteed – By 1880 most on gold standard – Balance of trade equilibrium for all countries  

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Value of exports should equal value of imports Flow of gold used to make up differences Abandoned in 1914  Failed resumption after WWI  Great Depression

Bretton Woods (1944 - 1973)

44 countries met to design a new system in 1944 Established: International Monetary Fund (IMF) and World Bank – IMF: maintain order in monetary system – World Bank: promote general economic development – Fixed exchange rates pegged to the US Dollar – US Dollar pegged to gold at $35 per ounce – Countries maintained their currencies ± 1% of the fixed rate; buy/sell own currency to maintain level The Role of the IMF: IMF maintained exchange rate

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National government governmentss had to manage manage inflation inflation through their money money supply



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The Role of the World Bank: World Bank (IBRD) role (International Bank for Reconstruction & Development) – Refinanced post-WWII reconstruction and development – Provides low-interest long term loans to developing economies

The International Development Agency (IDA), an arm of the bank created in 1960 – Raises funds from member states – Loans only to poorest countries – 50 year repayment at 1% per year interest –

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Collapse of Bretton Woods

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Devaluation pressures on US dollar after 20 years – Lyndon Johnson policies  Vietnam war financing  Welfare program financing – Nixon ended gold convertibility convertibility of US dollar in 1971 – US dollar was devalued and dealers started speculating against it for further devaluation – Bretton Woods fixed exchange rates abandoned in January 1972

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Jamaica Agreement 1976

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Floating rates declared acceptable Gold abandoned as reserve asset; – IMF returned gold reserves to members at current prices – Proceeds placed in trust fund to help poor nations – IMF quotas – member country contributions – increased; membership now 182 countries – Less-develop, non-oil exporting countries given more access to IMF  IMF continued its role of helping countries cope with macroeconomic and exchange rate problems The case for floating exchange Rates: – Monetary policy autonomy – Trade balance adjustments helped The Case for Fixed Exchange Rates – Monetary discipline – Speculation limited – Uncertainty reduced – Trade balance adjustment effects on inflation controlled 

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Recent Activities and the IMF: Mexican Crisis 1995 Russian Ruble crisis1995 Asian crisis 1997/1998 – Events The investment boom   Excess capacity  The debt bomb  Expanding imports  The crisis How does the IMF achieve results? – Inappropriate policies? – Moral Hazard? – Lack of accountability? –

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Managerial Implications

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Currency management – Currency market does not always work as expected – Government intervention – Speculative activity Business strategy – Movements in exchange rates are difficult to predict

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Financial Management in a Global Perspective

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