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International FinanceChapter 1Introduction International Business

1These slides primarily use the formulas to work the problems with a brief introduction to financial calculators.International financeInternational 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

2Whats Special about International Finance?Foreign Exchange RiskPolitical RiskMarket ImperfectionsExpanded Opportunity Set3Whats 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 change in unexpected ways.4Market Imperfections Legal restrictions on movement of goods, people, and moneyTransactions costsShipping costsTax arbitrage Expanded Opportunity SetIt doesnt make sense to play in only one corner of the sandbox.True for corporations as well as individual investors.

Whats Special about International Finance?5

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 TransactionSelling 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)7International Business TerminologyTrade DeficitWhen India imports more goods than it exports, we have what is called a Trade Deficit. Imports > Exports = Trade DeficitTrade SurplusWhen India exports more goods than it imports, we have a Trade Surplus. Exports > Imports = Trade SurplusWhich do you think is better for the Indian economy?

8Five Ps of International BusinessProduct: 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 available.

9Theories of International BusinessTheory of Comparative AdvantageSpecialization by countries can increase production efficiency.Different costs/skills between nationsImperfect Markets TheoryThe markets for the various resources used in production are imperfect. immobility of factors of productionProduct Cycle TheoryAs a firm matures, it may recognize additional opportunities outside its home country.Why are firms motivated to expand their business internationally?10International Business MethodsInternational 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.Sprint telecommunications in UK IGA supermarkets in China & Singapore

There are several methods by which firms can conduct international business.11International Business MethodsFranchising 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 networkAcquisitions of existing operations in foreign countries allow firms to quickly gain control over foreign operations as well as a share of the foreign market.P&G bought bleach company in Panama

12International Business MethodsFirms 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 characteristics of the MNC.13International OpportunitiesInvestment 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.14International OpportunitiesOpportunities in EuropeThe Single European Act of 1987.Uniform regulations & removal tariffsThe removal of the Berlin Wall in 1989.Expand into eastern EuropeThe inception of the euro in 1999.transparencyOpportunities in Latin AmericaThe North American Free Trade Agreement (NAFTA) of 1993.US, Mexico, CanadaThe General Agreement on Tariffs and Trade (GATT) accord.15International OpportunitiesOpportunities in AsiaThe 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 1997-1998.

16Exposure to International Riskexchange rate movementsExchange rate fluctuations affect cash flows and foreign demand.foreign economiesEconomic conditions affect demand.political riskPolitical actions affect cash flows.Terrorism 9/11/01 MNC from 50 countries had office space in WTCInternational business usually increases an MNCs exposure to:17Global-Level Cooperation Among NationsThe 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 another, produce goods with labor and capital equipment in a third country and sell their output in various other national markets.19THE RISE OF THE MULTINATIONAL CORPORATIONEVOLUTION OF THE MNC Reasons to Go Global:1. raw materials2. more markets3. minimize costs of production1.RAW MATERIAL SEEKERSexploit markets in other countrieshistorically first to appearmodern-day counterpartsAnaconda CopperStandard Oil20THE RISE OF THE MULTINATIONAL CORPORATION2.MARKET SEEKERSproduce and sell in foreign marketsheavy foreign direct investorsrepresentative firms:IBMNestleLevi Strauss3.COST MINIMIZERSseek lower-cost production abroadmotive: to remain cost competitiverepresentative firms:Texas InstrumentsAtariZenith21Top 10 MNCs1General ElectricUnited States2Ford Motor CompanyUnited States3Royal Dutch/Shell GroupNetherlands/ UK Netherlands/U.K. 4General MotorsUnited States5Exxon CorporationUnited States6ToyotaJapan7IBMUnited States8Volkswagen GroupGermany9Nestl SASwitzerland10Daimler-Benz AGGermany1-22Conflicts Against the MNC GoalFor 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 closer to the subsidiarys operations and environment.23Impact of Management ControlSome 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 value is increased by project but MNCs overall value is decreased.24Impact of Management ControlElectronic 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.Monitoring and intervention by large shareholders.25Constraints Interfering with the MNCs GoalAs MNC managers attempt to maximize their firms value, they may be confronted with various constraints.Environmental constraints.Differ e.g., pollution controlsRegulatory constraints.Taxes, currency convertibility, earnings remittingEthical constraints.Bribes 26Globalization & its Impact27Mile Stone Events That Have Affected BusinessEnd of World War I (1918)End of World War II (1945)End of Cold War (1989)9/11 (2001)Global Financial Market crisis (2008)28Globalization 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.29The Nobel Prize Winner Joseph Stiglitz defines Globalization as the removal of barriers to free trade and the closer integration of national economies and he believes that it 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. While John Galbraith talks about misgovernment of globalization. What these and other students of Globalization mean is that the whole process is potentially beneficial for development, as it saves resources, otherwise used for low efficient micro-management, but this process needs management by consciously prepared bodies governments, international organizations, and above all, globalization needs a rules-based system, in which the interests of all industrialized and poor nations alike need to be taken into account and managed in a system that provides international public goods. The Bretton Woods institutions are called to play a role in this international regime for the provision of public goods. A key role here belongs to the WTO and its binding rules, which need to take into account the interests of all, including the poorest developing countries. Yet, as Stiglitz argues, the problem is that the rich industrialized countries have imposed their interests and this is why the international trade agreements have to be rethought.

What about e-trade. The same issue - the need for good management of international e-commerce - applies. The WTO has had informal discussions about e-commerce, but there is no real work on binding WTO rules is envisaged in this area. ICTs come as part of other binding agreements services, IPRs, and now there are negotiations on trade facilitation, which may include obligations to publish all trade procedures on the Internet, build Single electronic Windows for filing trade information, etc. In this sense, the WSIS, managed by other UN agencies has made attempts to establish some basic rules, including governance of the Internet and creation of a Solidarity Fund for ICT development in the developing countries.

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 .

30The Nobel Prize Winner Joseph Stiglitz defines Globalization as the removal of barriers to free trade and the closer integration of national economies and he believes that it 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. While John Galbraith talks about misgovernment of globalization. What these and other students of Globalization mean is that the whole process is potentially beneficial for development, as it saves resources, otherwise used for low efficient micro-management, but this process needs management by consciously prepared bodies governments, international organizations, and above all, globalization needs a rules-based system, in which the interests of all industrialized and poor nations alike need to be taken into account and managed in a system that provides international public goods. The Bretton Woods institutions are called to play a role in this international regime for the provision of public goods. A key role here belongs to the WTO and its binding rules, which need to take into account the interests of all, including the poorest developing countries. Yet, as Stiglitz argues, the problem is that the rich industrialized countries have imposed their interests and this is why the international trade agreements have to be rethought.

What about e-trade. The same issue - the need for good management of international e-commerce - applies. The WTO has had informal discussions about e-commerce, but there is no real work on binding WTO rules is envisaged in this area. ICTs come as part of other binding agreements services, IPRs, and now there are negotiations on trade facilitation, which may include obligations to publish all trade procedures on the Internet, build Single electronic Windows for filing trade information, etc. In this sense, the WSIS, managed by other UN agencies has made attempts to establish some basic rules, including governance of the Internet and creation of a Solidarity Fund for ICT development in the developing countries.

GlobalizationGlobalization 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), and on economic development and prosperity of societies across the world.31Definition: GlobalizationA 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) A new kind of non-physical place is emerging (supraterritoriality)

32Globalization can be defined as the worldwide integration of economic, cultural, political, religious, and social systems.

Definition: GlobalizationOne way to approach this: think about the world before globalizationDistance 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)

33Globalization can be defined as the worldwide integration of economic, cultural, political, religious, and social systems.

Globalization Forces driving globalization? The technological change since industrial revolution led to explosion of productivity and slashed transportation cost. Electricity, telephone , automobile, pipelines altered the communication and transportation ways .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.The liberalization of trade and investment results in multilateral trade negotiations. Globalization has been promoted through the widespread of investment transactions and the development of international markets.34The Nobel Prize Winner Joseph Stiglitz defines Globalization as the removal of barriers to free trade and the closer integration of national economies and he believes that it 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. While John Galbraith talks about misgovernment of globalization. What these and other students of Globalization mean is that the whole process is potentially beneficial for development, as it saves resources, otherwise used for low efficient micro-management, but this process needs management by consciously prepared bodies governments, international organizations, and above all, globalization needs a rules-based system, in which the interests of all industrialized and poor nations alike need to be taken into account and managed in a system that provides international public goods. The Bretton Woods institutions are called to play a role in this international regime for the provision of public goods. A key role here belongs to the WTO and its binding rules, which need to take into account the interests of all, including the poorest developing countries. Yet, as Stiglitz argues, the problem is that the rich industrialized countries have imposed their interests and this is why the international trade agreements have to be rethought.

What about e-trade. The same issue - the need for good management of international e-commerce - applies. The WTO has had informal discussions about e-commerce, but there is no real work on binding WTO rules is envisaged in this area. ICTs come as part of other binding agreements services, IPRs, and now there are negotiations on trade facilitation, which may include obligations to publish all trade procedures on the Internet, build Single electronic Windows for filing trade information, etc. In this sense, the WSIS, managed by other UN agencies has made attempts to establish some basic rules, including governance of the Internet and creation of a Solidarity Fund for ICT development in the developing countries.

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 overlapping, adapting, clashing, merging

35Globalization and Its Impact Effects of globalization on: 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. 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 globalization adds to employment.36Globalization 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 rely on export markets to sell their products, rich countries can use the threat of trade sanction to coerce policies that attempt to curtail child labour. This has positive impact on child labour.

37Globalization 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. Industrialization has benefitted mainly the already rich countries while the poor countries have become poorer. 38Globalization and Its Impact onI. 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.39Globalization 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.(Bourdeaux 2008, Gwartney & Lawson 2001)40Globalization and Its Impact III. In 1990 Kenichi Ohame observed the 5 cs of a firms environment influenced by globalization influenced by globalization:Customer: Globalization advocates free capitalist economy where customer is the king. Firms socialization should have customers focus.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.Company: Companys success depends on commitment to globalization by pulling all its effects in enhancing its efficiency & competitive edge for a better performance.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.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.41Globalization & IndiaIndia Went Through Economic Reforms From 1991. The major ones are:Reductions In Import DutyRemoval of restrictions on importsDevaluation of CurrencyRemoval of permissions on setting up enterprises and expansion of capacityRemoval of permission of Controller of Capital on Share Premium Account on issues of SharesPrivatization of Public Sector UnitsMembership of WTOEasier entry of multinationals42

Globalization of the World Economy: Recent Trends

Emergence of Globalized Financial MarketsTrade Liberalization and Economic Integration Privatization

43Deregulation of Financial Markets coupled withAdvances in Technology have greatly reduced information and transactions costs, which has led to: Financial Innovations, such asCurrency futures and optionsMulti-currency bondsCross-border stock listingsInternational mutual fundsEmergence of Globalized Financial Markets44Economic IntegrationOver 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 their citizenry.45Liberalization of Protectionist LegislationThe 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 15-year period.46Privatization

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.

47WTO AND ITS IMPACT48Global-Level Cooperation Among NationsThe 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. 49WORLD TRADE ORGANIZATIONWhat 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 day-to-day administration; and a director-general, who is appointed by the ministerial conference

50The World Trade Organization (WTO)

Exhibit :Multilateral negotiations under GATT

Doha Round 2002- 149 --51WORLD TRADE ORGANIZATIONThe 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 businessWTO 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 agreements. It is a place for them to settle trade disputes. It operates a system of trade rules. 52The 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 costProvide 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 organizationslike IMF,WB to achieve greater coherence in global economic policy making.

53The 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 industries.54WORLD BANK or THE INTERNATIONAL BANK FOR RECONSTRUCTION & DEVELOPMENT (IBRD)ROLE OF WORLD BANK55THE WORLD BANKThe 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 to the world economy.Purpose : The World Bank aids in the development and reconstruction of it members.

56THE WORLD BANKThe 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): - encourages foreign investment by providing international facilities for conciliation & arbitration of investment disputes, thus creating atmosphere of mutual confidence between developing countries & foreign investors.

57The 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., the World Bank is, by custom, headed by an American, while the IMF is led by a European

Role of World Bank58Role of World BankThe 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 Corporation (IFC), Multilateral Investment Guarantee Agency (MIGA), and International Centre for Settlement of Investment Disputes (ICSID).

59 ROLE OF IMF 60The International Monetary Fund (IMF)Set up in 1944 at the Bretton Woods Conference, New HampshireSet up to help put in place an economic structure that would help prevent the problems experienced by many countries in the 1930sAims to stabilise the international monetary system and help when monetary flow from trade causes problemsProvides help and advice as well as funds to countries experiencing balance of payments problems

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The Operation of the IMFIMF 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 toPromote international monetary cooperationFacilitate the expansion of international tradePromote exchange stability and a multilateral system of paymentsMake temporary financial resources available to members under adequate safeguardsReduce the duration and degree of international payments imbalances62The Operation of the IMFMajor decision-making body is its Board of Governors -Each member appoints a Governor and an Alternate GovernorDay-to-day business rests in the hands of Executive Board -Composed of 22 Executive Directors plus Managing DirectorSix of the 22 Executive Directors are appointed by largest IMF quota holders Remainder elected by groups of member countries not entitled to appoint Executive DirectorsManaging Director is appointed by Executive Board and is traditionally European (often French)Chairs Executive Board and conducts IMFs businessCurrently three Deputy Managing Directors63 Administrative Structure of the IMF

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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, stabilizing their currencies, and paying for importsall necessary conditions for relaunching growth. The IMF also provides concessional loans to low-income countries to help them develop their economies and reduce poverty.65The Operation of the IMFMost 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 powerMembers quotas are their subscriptions to the IMFBased on their relative sizes in the world economyPays one fourth of its quota in widely-accepted reserve currencies (US dollar, British pound, euro, or yen) or in Special Drawing RightsPays remaining three-quarters of quota in its own national currency66The Operation of the IMFThe IMF engages in four areas of activityEconomic surveillance or monitoringDispensing of policy adviceLendingPerhaps most importantTechnical assistance67Tranche (i.e. share, % or portion of money)If an IFM member faces balance of payments difficultiesCan automatically borrow one fourth of its quota in the form of a reserve trancheWhen the IMF lends to a member country, what actually happens is domestic country purchases international reserves from the IMF using its own domestic currency reservesMember country is then obliged to repay IMF by repurchasing its own domestic currency reserves with international reserve assetsIMF lending is known as a purchase-repurchase arrangement68TrancheCredit tranchesOriginally, each were equal to of the members quotasIn the late 1970s, credit tranches were increased to 37.5% of quotaFirst credit tranche is more or less automaticSecond through fourth credit tranches require that the member adopt policies (conditionality) that will solve balance of payments problem at handEffectively limits a member countrys credit to 150 percent of its quotaAs 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 repaidFive-year limit was established69Figure IMF Lending

70Table Special Credit Facilities

71Ideal Role of the IMFDevelopment of a country requires an inflow of private foreign savings Inflow would cover a current account deficit often caused by import of capital goodsOccasionally, this private foreign savings disappearsResulting in a balance of payments crisisIn these instances IMF steps inMember draws on its reserve and credit tranchesRepaying credit tranche debts in five years timeThus, IMF offers short-term credit, stepping in to replace private foreign savings on those rare occasions72

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 andMaking its resources available (under adequate safeguards) to members experiencing balance of payments difficulties.

73History of IMF Operations1950s-1960sIn its initial years, the IMF was nearly irrelevantHowever, Suez crisis of 1956 forced Britain to draw on its reserve and first credit tranchesJapan drew on its reserve tranche in 1957Between late 1956 through 1958 IMF was involved in policies that lead to the convertibility of both British pound and French francConcerned about the United States ability to defend the dollar and other major industrialized countries abilities to maintain their paritiesIMF introduced the General Arrangements to Borrow (GAB) in October 1962Involved the central banks of ten countries setting aside a $6 billion pool to maintain stability of Bretton Woods systemCountries involved became known as Group of Ten or G-10 and comprised a rich countries club74History of IMF OperationsMid-to-Late 1960sBy 1965, US faced two unappealing optionsReduce world supply of dollars to enhance international confidence by reducing international liquidityExpand world supply of dollars to enhance international liquidity by reducing international confidenceBut 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 dollarKnown as a special drawing right or SDR75History of IMF OperationsSpecial Drawing Rights, 1970sCame into being in July 1969In 1971, when United States broke gold-dollar link, the SDR was redefined in terms of a basket of five currenciesdollar, pound, mark, yen, and francAllocated in proportion to members quotasNever played the important role envisaged for themPerhaps best seen as one of many attempts to resolve Triffin dilemma76History of IMF Operations, 1970sOil price increases of 1973-1974 caused substantial balance of payments difficulties for many countries of the worldIn June 1974, the IMF established an oil facility to assist these countriesActed as an intermediary, borrowing funds from oil producing countries and lending them to oil importing countriesA second oil facility was established in 1975Slightly more strict than the firstDuring this time, a bias towards private-sector lending helped to prevent sufficient increases in IMF quotasGiven the limits of the quota system, IMF was becoming more of a financial intermediaryless of an international cooperative credit arrangement77History of IMF Operations, 1970s-1980sIn 1976, IMF began to sound warnings about sustainability of developing-country borrowing from commercial banking systemBanking system reacted with hostility to these warningsArgued Fund had no place interfering with private transactionsThe 1980s began with a significant increase in real interest rates and a significant decline in non-oil commodity pricesIncreased cost of borrowing and reduced export revenues78History of IMF Operations1980sIn 1982, IMF calculated that US banking system outstanding loans to Latin America represented approximately 100% of total bank capitalIn August 1982 Mexico announced it would stop servicing its foreign currency debtAt the end of the month, Mexican government nationalized its banking system1982 also found debt crises beginning in Argentina and BrazilArgentina: Overvalued exchange rate, used as a nominal anchor to curb inflationary expenditures Brazil: Rates of devaluation did not keep up with rates of inflation, causing an overvalued real exchange rate79History of IMF Operations, 1980sInternational commercial banks began to withdraw credit from many of the developing countries of the worldDebt crisis became globalWithin a few years of outbreak phenomenon of net capital outflows appearedInvolved capital account payments of debtor countries exceeding capital account receiptsBy second half of 1980s, some debt was trading at discounts in secondary marketsIn 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 debtAmounted to partial and long-needed debt forgiveness, were approved by the IMF and became known as the Brady PlanAlso allowed for extending time periods of debt and provided for new lending80History of IMF Operations, 1990sStarting in the 1990s, private, non-bank capital began to flow to developing countries in the form of both direct and portfolio investmentNumber of highly-indebted countries began to show increasing unpaid IMF obligationsIn November 1992, a Third Amendment to the Articles of Agreement allowed for suspension of voting rights in the face of large, unpaid obligationsMexico underwent a second crisis in late 1994 and early 1995IMF was unable to respond effectivelyUS Treasury assembled a loan package81History of IMF Operations, 1990sIn 1997-1998, crises struck a number of Asian countriesmost notably Thailand, Indonesia, South Korea, and Malaysia and also RussiaResulted in sharp depreciations of the currenciesIn the cases of Thailand, Indonesia, and South Korea, IMF played substantial and controversial roles in addressing crisesLoan packages were designed with accompanying conditionality agreementsSupplementary Reserve Facility was introduced to provide large volumes of high-interest, short-term loans to selected Asian countriesIn October and November 1998, IMF put together a package to support Brazilian currency, the realAttempt to prevent Asian and Russian crises from spreading to Latin AmericaStill, Brazil was forced to devalue the real in January 199982History of IMF Operations, 1990sRecent years have witnessed important changes at the IMFIn 1997 General Agreement to Borrow was supplemented by the New Arrangement to BorrowInvolves 25 IMF members agreeing to lend up to US$46 billion to IMF in instances where quotas prove to be insufficientIn 1999, a new lending facility was addedPoverty Reduction and Growth Facility was created to replace the 1987 Enhanced Structural Adjustment FacilityRepresents beginning of an attempt to integrate poverty reduction consideration into macroeconomic policy formation of IMFIn 1999, quotas were increased by 45% to a total of US$283 billion83History of IMF Operations, 2000sThe 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 next few years. The budget proposal includes sharp spending cuts of $100 million until 2011 that will include up to 380 staff dismissals.[12]84History of IMF Operations ,2000sAt 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 G-20, 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. As of August 2010, Romania ($13.9 billion), Ukraine ($12.66 billion), Hungary ($11.7 billion), and Greece ($30 billion) are the largest borrowers of the fund.

85The Monetary System86Evolution of the International Monetary SystemBimetallism: Before 1875Classical Gold Standard: 1875-1914Interwar Period: 1915-1944Bretton Woods System: 1945-1972The Flexible Exchange Rate Regime: 1973-Present87The Monetary SystemBimetallism: 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 of circulation88The Monetary SystemClassic gold standard: 1875-1914Great 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.Gold alone is assured of unrestricted coinageThere is a two-way convertibility between gold and national currencies at a stable ratioGold may be freely exported and importedCross-border flow of gold will help correct misalignment of exchange rates and will also regulate balance of payments.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.

89The Monetary SystemInterwar period: 1915-1944World War I ended the classical gold standard in 1914Trade in gold broke down After the war, many countries suffered hyper inflationCountries 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.After the great depression, and ensuing banking crises, most countries abandoned the gold standard.90

The Monetary System

Bretton Woods system: 1945-1972Named 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