INTERNATIONAL FINANCE

Lecture 6

• Balance of Payment (Accounting of transactions)– Current Account– Capital Account

• Current Account (Purchase Summary)– Balance of Trade (Imports & Exports)– Factor Income (Cash Inflows & outflows)– Transfer Payments (Aid, Gift, Grants)

Overview

• Capital Account (Flow of funds; one country to other)– Direct Foreign Investment– Portfolio Investment– Capital Investment

• Trade Agreements– NAFTA, GATT, EU

• Trade Disagreements– Tariffs, Quotas, Job loss– Rules are different (Child labor, Bribe, etc)– Outsourcing

Overview

Using Trade Policies for Political Reasons

• People expect to use trade policies for the punishment to the other countries

• They expect to restrict imports from countries where child labor and environmental laws are not enforced

• The managers of MNCs cannot resolve all these conflicts arising from trade policies but they should know that how trade policies will affect their competitive position in the industry

Disagreements within the European Union

• In 2004 ten countries from eastern Europe joined the EU

• Firms in these countries are subject to reduced trade barriers

• While these countries are also subject to EU tariffs• Like EU places a 75% tariff on the import of

banana from other European countries• It causes an increase in prices and friction among

EU countries

Factors AffectingInternational Trade Flows• Impact of Inflation

– If a country’s rate of inflation increases from the country with which it trades so it will decrease its current account,

– Imports increase and exports decrease in this case

Factors AffectingInternational Trade Flows

• Impact of National Income

– A relative increase in a country’s income level will decrease its current account,

– Demand for foreign goods will increase – Consumption of imports will increase

• Impact of Government Restrictions– A government may reduce its country’s imports

by imposing a tariff on imported goods, or by enforcing a quota.

– Some trade restrictions may be imposed on certain products for health and safety reasons.

– Tariffs by Government increase the prices of foreign goods

Factors AffectingInternational Trade Flows

• Impact of Exchange Rates– If a country’s currency begins to rise in value,

its current account balance will decrease as imports increase and exports decrease.

– When currency appreciates exports will be expensive for the other countries

– Demand for such products will decrease

Factors AffectingInternational Trade Flows

Correcting A Balance of Trade Deficit

• By reconsidering the factors that affect the balance of trade, some common correction methods can be developed.

• A floating exchange rate system may correct a trade imbalance automatically since the trade imbalance will affect the demand and supply of the currencies involved.

International Capital Flows

Distribution of DFIFor 2003, in millions of dollars

Source: U.S. Bureau of Economic Analysis

All countries 151,884 100.0% 29,772 100.0%America 26,997 17.8% 12,641 42.5%

Canada 13,826 9.1% 9,116 30.6%Mexico 5,667 3.7% 1,944 6.5%

Europe 99,191 65.3% 6,572 22.1%Germany 8,676 5.7% 407 1.4%Netherlands 14,968 9.9% -614 -2.1%Switzerland 14,444 9.5% -6,993 -23.5%United Kingdom 39,548 26.0% -2,288 -7.7%

Africa 2,211 1.5% -50 -0.2%Middle East 2,093 1.4% 522 1.8%Asia & Pacific 21,392 14.1% 10,086 33.9%

Japan 5,800 3.8% 6,495 21.8%

U.S. DFI DFI in the U.S.

Factors Affecting DFI• Changes in Restrictions– New opportunities may arise from the

removal of government barriers.• Privatization– Acquisitions– Managerial efficiency is must– DFI has also been stimulated by the selling

of government operations.• Potential Economic Growth– Countries that have higher potential for

economic growth are more attractive.

• Tax Rates– Countries that impose relatively low tax rates on

corporate earnings are more likely to attract DFI.• Exchange Rates– Firms typically prefer to invest in countries

where the local currency is expected to strengthen against their own.

Factors Affecting DFI

Factors Affecting International Portfolio Investment• Tax Rates on Interest or Dividends– Investors will normally prefer countries

where the tax rates are relatively low.• Interest Rates– Money tends to flow to countries with high

interest rates.• Exchange Rates– Foreign investors may be attracted if the

local currency is expected to strengthen.

• International Monetary Fund- IMF (1944)– The IMF encourages internationalization of

businesses through surveillance, and financial and technical assistance.

– Its compensatory financing facility attempts to reduce the impact of export instability on country economies.

– The IM F adopts a quota system for its members based on country’s economic status.

– The amount of fund each member can get depends on its quota.

Agencies that Facilitate International Flows

• World Bank– This International Bank for Reconstruction and Development

makes loans to countries to enhance their economic development.

– Its main source of funds is the sale of bonds to private sector & government.

– In particular, its Structural Adjustment Loans (SALs- 1980) are intended to enhance a country’s long-term economic growth.

– Mostly offered to less development countries to improve balance of trade

– Funds are spread through co-financing agreements with official aid agencies, export credit agencies, and commercial banks.

Agencies that Facilitate International Flows

• Multilateral Investment Guarantee Agency MIGA– Established by the World Bank, – It helps to develop international trade and

investment by offering various forms of political risk insurance.

• International Development Association– The IDA extends loans at low interest rates to poor

nations that cannot qualify for loans from the World Bank.

Agencies that Facilitate International Flows

• World Trade Organization– The WTO was established to provide a

forum for multilateral trade negotiations and to settle trade disputes

• International Financial Corporation– The IFC promotes private enterprise within

countries through loan provisions and stock purchases.

Agencies that Facilitate International Flows

• Bank for International Settlements– The BIS is the “central banks’ central bank”

and “lender of last resort.”• Regional development agencies– Inter-American Development Bank– Asian Development Bank– African Development Bank– European Bank for Reconstruction and

Development.

Agencies that Facilitate International Flows

• Economic Factors Affecting Trade– Inflation– Impact of National Income– Government Restrictions– Foreign Exchange Rates• International Capital Flows• Factors Affecting International Trade flows• Factors affecting DFI• Factors Affecting Portfolio Investment• Agencies that Facilitate International Trade

Source: Adopted from South-Western/Thomson Learning. 2006

Overview