E Book

Module I FOUNDATION OF INTERNATIONAL BUSINESS
1.0 Learning Outcomes

Introduction Origin of international business Multinational Enterprises International Marketing International Trade Theories The Product Life Cycle Theory
1.1 Introduction
The beverages you drink might be produced in India, but with the collaboration of a USA company, the tea you drink is prepared from the tea powder produced in Sri Lanka. The spares and hard-disk of the computer you operate might have been produced in the United States, of America. The perfume you apply might have been produced in France. The television you watch might have been produced with the Japanese technology; the shoes you wear might have been produced in Taiwan, but remarketed by an Italian company. Your air-travel services might have been provided to you by Air-France and so on so forth.
MBA - IV Semester - International Business
Most of you have the experience of browsing internet and visiting different web sites, knowing the products and services offered by various companies across the globe. Some of you might have the experience of even ordering and buying the products through internet. This process gives you the opportunity of transacting in the international business arena without visiting or knowing the various countries and companies across the globe. You get all these even without visiting or knowing the country of the company where they are produced. All these activities have become a reality due to the operations and activities of international business. Thus, international business is the process of focusing on the resources of the globe and objectives of the organizations on global business opportunities and threats, in order to produce, buy, sell or exchange of goods/services world-wide. International trade has been playing a significant role in the functioning of the national economies for a long time. Even in ancient times international trade was important for the Egyptians, the Greeks, the Romans, and the Phoenicians and later for Spain, Portugal, Holland and Britain. All the great nations of the past that were influential world leaders were also important world traders. Nevertheless the importance of international trade and finance in determining economic health and standard of living of a country has never been a pronounced as it today. With trade liberalization and globalization, international transactions are all around us. The clothes that we wear, the shoes that adorn our feet, the food we eat, the car we drive, the appliances we use and different services that we enjoy come from different countries. Even when we use these items made in our country, it is very likely that they are made of components outsourced from many locations outside the country. International trade has expanded the consumption possibility frontiers of people living in different countries much beyond their respective production possibility frontiers. The increased internationalization of economic life is also experienced in terms of capital movements between the countries. People now invest their capital and produce goods and own assets in other countries on a larger scale than they did earlier.
1.2 Origin of International Business

The origin of international business goes back to human civilization. Historically periods of greater openness to trade have been characterized by stronger but lopsided global growth. The concept of international business-a broader concept relating to the integration of economies and societies, dates, back to the 19th century. The first phase of globalization began around 1870 and ended with the World War I (1919) driven by the industrial revolution in the UK, Germany and the USA, The import of raw materials by colonial empires from their colonies and exporting finished goods to their overseas possessions was the main reason for the sharp increase in the trade during this phase. The ratio of trade to GDP was as high as 22.1 in 1913, Later various Governments initiated and
Module 1 - Foundation of Inetrnational Business
imposed a number of barriers to trade to protect their domestic production that led to decline in the ratio of trade to GDP to 9,1 during 1930s.The international trade between two world wars has been described as a vast game of beggar-my-neighbour. Advanced countries experienced a severe setback consequent upon the imposition of trade barriers as they produced in excess of domestic demand and a decline in the volume of international trade, Added to this, the breakdown of the gold standard resulted in vacuum in the field of international trade. Then the world nations felt the need for international co-operation in global trade and balance of payments affairs, These efforts resulted in the establishment of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD-popularly known as the World Bank), The prolonged recession before the World War II in the West, led to an international consensus after the World War II that a different approach towards international trade was required. Consequently, 23 countries conducted negotiations in 1947 in order to prevent the protectionist policies and to revive the economies from recession aiming at the establishment of the International Trade Organization. This attempt of the advanced countries ended with the General Agreement on Trade and Tariffs (GATT) that provided a framework for a series of rounds of negotiations by which tariffs were reduced. Efforts to convert the General Agreement on Trade and Tariffs (GATT) into World Trade Organization (WTO) were intensified during 1980s and ultimately GATT was replaced by the WTO on 11 January 1995, envisaging trade liberalization. The efforts of IMF, World Bank and WTO along with the efforts of individual countries due to economic limitations of the closed economies led to the globalization of business. Globalization gave fill up to international business particularly during 1990s. In fact, the term international business was not popular before two decades. The term international business has emerged from the term international marketing, which, in turn, emerged from the term international trade.
1.2.1 International Trade

International trade is exchange of capital, goods, and services across international borders or territories.[1] In most countries, it represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history (see Silk Road, Amber Road), its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. International trade is a major source of economic revenue for any nation that is considered a world power. Without international trade, nations would be limited to the goods and services produced within their own borders. International trade is in principle not different from domestic trade as the motivation and the behavior of parties involved in a trade does not change fundamentally depending on whether trade is across a
border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or a different culture. International trade uses a variety of currencies, the most important of which are held as foreign reserves by governments and central banks. Here the percentage of global cumulative reserves held for each currency between 1995 and 2005 are shown: the US dollar is the most sought-after currency, with the Euro in strong demand as well. Another difference between domestic and international trade is that factors of production such as capital and labor are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Then trade in goods and services can serve as a substitute for trade in factors of production. Instead of importing the factor of production a country can import goods that make intensive use of the factor of production and are thus embodying the respective factor. An example is the import of labor-intensive goods by the United States from China. Instead of importing Chinese labor the United States is importing goods from China that were produced with Chinese labor. International trade is also a branch of economics, which, together with international finance, forms the larger branch of international economics.
1.2.2 Features of International Trade

Economists were earlier divided on the issue whether international trade has distinctive features necessitating a separate study. One school felt that there is no significant difference between international trade and inter-regional trade. No doubt, inter-regional trade refers to trade between two countries. Yet, when we consider a large country like India with diverse language and cultural differences and long distances separating one region from the other, there is very little to distinguish between international trade and inter-regional trade. The other school of economists strongly felt the need for a separate study of international trade as the existence of two sovereign states with separate legal, political and currency systems added new dimensions to international trade which are absent in interregional trade. The differences between international and inter-regional trade is now well recognized. It is sanctioned even by those who oppose the division that they differ in relative terms, though not absolutely. The salient features of international trade described below also serve to distinguish it from interregional trade. 1. Factor Immobility Factors of production are more mobile between regions within a country than between two countries. There are economic, social and political reasons for this. For
instance, countries follow protective tariff policies immigration policies and industrial policies that inhibit free flow of goods, labour and capital respectively between the countries. It is often said that the labour is the most prevent labour going to other countries. Such factors are not present for movement between regions within a country. 2. Different Currencies A critical difference between inter-regional and international trade is the use of different currencies in foreign trade but a common currency in inter-regional trade. So international trade is limited by the extent of liquidity of foreign exchange while there are no such restrictions in inter-regional trade. Issue of balance of payments The fact that balance of payments should balance between any two countries in the long run restricts the volume of demand for goods and services produced in the other nation. If the domestic country cannot export equivalent amount of exports, then there is a restriction on the amount of goods and services that it can import also. Such a restriction is absent for interregional trade. Difference in political institutions Regions within a country are governed by common political system. While between countries the political ideology may differ. This may result in frictions to international trade. For example, if India has bilateral trade connections with Russia it may affect our trade relations with USA Different national policies Countries may pursue various domestic policies with regard to trade, industry, commerce and so on. So trade between regions will not be affecting such difference. While those differences matter in international trade. For example, non-tariff barriers regarding environment, child labour, etc. may create problems in the international market. Domestic environmental laws may allow the production process of certain commodities, while they may be rejected in the international market. Difference in constitutional policy The constitution mandates protection of inter-regional trade by preventing any provincial government from framing policies that obstruct trade between regions. On the other hand, there are constitutional provisions that enable the national government to frame policies that protect the domestic industries from external competition and thereby reduce free flow of international goods into domestic economy.
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1.2.3 Importance of International Trade

International trade is important because it increases economic welfare through higher income and employment of the trading countries. It helps the countries to benefit from economies of scale due to territorial division of labour it increases the consumption possibilities of trading countries. The significance and relevance of international trade has never been as visible or palpable as in the present context of a liberalized and global economy. The effects of trade liberalization is seen and felt in all aspects of life
from what people eat to what movies they see. The consumption possibility frontier has become an elusive and ever receding line. International trade expands the market for production and this leads territorial division of labour. The countries reap the advantage of economies of scale resulting from specialization. The increased production leads to higher employment and higher income, higher economic welfare People in different countries get access to increased volumes of goods and services of higher quality and this leads to the expansion of consumption possibility frontier With the growing importance of international trade to countrys economic health it will be instructive to understand the theories of international trade which explains the basis for trade between countries.
1.2.4 Current Trends in International Trade

Todays world trade manifests certain characteristics, an understanding of which will make the study of international trade more meaningful for international policy making. The following salient features are observed from the analysis of international trade data
1.2.5 Growth in Merchandise Trade

World trade in merchandise has had a perceptible increase in the annual percentage change of 5% in the last decade. All the regions in the world have experienced a rise in the percentage change in merchandise trade. Some regions like Asia, East Asian countries have grown higher than world average growth rate annually. The annual average growth in percentage terms is different across regions.
1.2.6 Commodity composition of Trade

Nearly 75% of the value of trade comes from manufacturers and 25% from primary good including food whose share is the largest. Developing countries have competitive advantage in primary products and their major exports are food and allied items and developed countries mainly export manufactured goods and high technology products. Over the years one observes a gradual decline in the relative share of food in primary products. The demand for primary products tends to be goods have declined. The primary goods have not enjoyed a price rise similar to the manufactured goods. Hence developing countries have not been able to experience the gains from trade as developed countries.
World Trade in Services Trade in services include retail and wholesale trade, restaurants and hotels, transport, storage, communication, financial services, insurance, real estate, business services, personal services, community, social and government services. World trade in services has grown in importance due to the fact that services account for the largest share in income and employment in most of the developed countries and for some of the developing countries like India. Advantages of International Business & Trade 1. Gains from trade. Pure theories of international trade show forcefully that free trade is mutually advantageous to the trading countries because it allows the countries to reap the benefits of specialization in certain goods for which each country is best suited. It also shows how the gains are shared between the trading partners. Gains from trade depend upon the terms of trade which is the price ratio at which goods are exchanged by a country with other countries. Terms of trade again depends upon the size of the market, elasticity of export, import demand, tariff policy pursued by the government, and so on. 2. Pattern of trade. International trade theories tell why certain countries are best suited for the production of certain commodities than other countries. It tries to explain the pattern of tradewho sells what to whom and why? The earlier theories dealing with the basis for trade, Absolute Cost Advantage by Adam Smith, Comparative Cost Advantage by David Ricardo and the modern theory or Factor Endowment model by Heckscher-Ohlin all focus on finding answers to what decides the pattern of trade. 3. Protectionism. Protectionism is a crucial policy issue in international economics. The countries get involved in eternal battle between free trade and protectionism. International economics is crucially concerned with the effects of these protective tariff, and quotas on the countrys welfare. Economic theory proves the advantages of free trade formally by using theoretical tools. 4. Balance of payment. The balance of payment shows the record of a countrys economic transactions with the rest of the world. Apart from international trade in goods and services, there are other economic transactions like capital movements among the countries. The monetary implications of all these movements are captured in the balance of payments. Explaining the importance of the balance of payment and analyzing its impact on the economy is a major theme in international economics. It also studies the implication of the imbalance in balance of payments accounts, the causes that give rise to balance of payments imbalance and the alternative measures appropriate in handling them. 5. Exchange rate determination. Exchange rate is the price at which one currency is traded for another currency. This is yet another critical issue discussed under international economics. We know that trading countries have different currencies. When relative prices of currencies change drastically the effect may be quite different on the countries trade outcomes. Hence knowledge of the factors
influencing exchange rate determination becomes very important. Merits and demerits of fixed us. Flexible exchange rates is a standard discussion in this context. 6. International policy co-ordination. International transactions take place between independent countries which are free to pursue their respective monetary and fiscal policies. However such internal policies may affect trade and capital movements between countries in a conflicting manner. For example, when a countrys interest rate is raised by its Central Bank to control domestic inflation, this may increase the capital inflow into that country. Even a minor rise in the interest rate may trigger a large capital inflow into the country and this will affect other countries capital inflow. Hence it is necessary that countries adopt policies in harmony with each other. It is in this regard institutions such as General Agreements on Trade and Tariff (GATT) and WTO have been founded. The fourth part of this book deals with WTO, its objective and role in international trade today. 7. International capital movement. Since 1960s international trade has grown along with international capital movements. International capital markets are different from domestic capital markets in two respectsfirst one is the currency fluctuations; relative value of the currencies fluctuates frequently. Secondly, special regulation that any country may impose on foreign investment. Even in liberalized trade regime, countries impose certain restrictions on foreign capital both with regard to the extent of investment and the nature of investment. Countries choose to allow foreign investment in lines that are essential for domestic economyfor example, infrastructure, energy and industries that will permit transfer of technology, and so on. They use it as an instrument of industrial policy. Capital movement across countries occurs in various forms. Models of International Trade The Ricardian model focuses on comparative advantage and is perhaps the most important concept in international trade theory. In a Ricardian model, countries specialize in producing what they produce best. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods. Also, the Ricardian model does not directly consider factor endowments, such as the relative amounts of labor and capital within a country. Assumptions of the Ricardian model (1) Labor is the only primary input to production (labor is considered to be the ultimate source of value). (2) Constant Marginal Product of Labor (MPL) (Labor productivity is constant, constant returns to scale, and simple technology. (3) Limited amount of labor in the economy (4) Labor is perfectly mobile among sectors but not internationally. (5) Perfect competition (pricetakers). The Ricardian model measures in the short-run, therefore technology differs internationally. This supports the fact that countries follow their comparative advantage and allows for specialization. The Ricardian trade model was studied by Graham, Jones, McKenzie and others. All the theories excluded intermediate goods, or traded input goods such as materials and capital goods. Recently, the theory was extended to the case that includes traded intermediates. Thus the assumption (1) was
removed from the theory. McKenzie (1954), Jones (1961) and Samuelson (2001) emphasized that considerable gains from trade would be lost once intermediate goods were excluded from trade. In a famous comment McKenzie pointed that A moments reflection will convince that Lancashire would not be unlikely to produce cotton cloth if the cotton has to be grown in England. Heckscher-Ohlin model The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of basic comparative advantage. Despite its greater complexity it did not prove much more accurate in its predictions. However from a theoretical point of view it did provide an elegant solution by incorporating the neoclassical price mechanism into international trade theory. The theory argues that the pattern of international trade is determined by differences in factor endowments. It predicts that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce. Empirical problems with the H-O model, known as the Leontief paradox, were exposed in empirical tests by Wassily Leontief who found that the United States tended to export labor intensive goods despite having capital abundance. Core assumptions of the H-O model: (1) Labor and capital flow freely between sectors (2) The production of shoes is labor intensive and computers is capital intensive (3) The amount of labor and capital in two countries differ (difference in endowments) (4) free trade (5) technology is the same across countries (long-term) (6) Tastes are the same. The problem with the H-O theory is that it excludes the trade of capital goods (including materials and fuels). In the H-O theory, labor and capital are fixed entities endowed to each country. In a modern economy, capital goods are traded internationally. Gains from trade of intermediate goods are considerable, as it was emphasized by Samuelson (2001). Specific factors model Global Competitiveness Index (2006-2007): competitiveness is an important determinant for the wellbeing of states in an international trade environment. In this model, labour mobility between industries is possible while capital is immobile between industries in the short-run. Thus, this model can be interpreted as a short run version of the Heckscher-Ohlin model. The specific factors name refers to the given that in the short-run, specific factors of production such as physical capital are not easily transferable between industries. The theory suggests that if there is an increase in the price of a good, the owners of the factor of production specific to that good will profit in real terms. Additionally, owners of opposing specific factors of production (i.e., labour and capital) are likely to have opposing agendas when lobbying for controls over immigration of labour. Conversely, both owners of capital and labour profit in real terms from an increase in the capital endowment. This model is ideal for particular industries. This model is ideal for understanding income distribution but awkward for discussing the pattern of trade.
10 1.3 International Marketing
International marketing refers to marketing carried out by companies overseas or across national borderlines. This strategy uses an extension of the techniques used in the home country of a firm. International marketing is simply the application of marketing principles to more than one country. However, there is a crossover between what is commonly expressed as international marketing and global marketing, which is a similar term. The intersection is the result of the process of internationalization. Many American and European authors see international marketing as a simple extension of exporting, whereby the marketing mix 4Ps is simply adapted in some way to take into account differences in consumers and segments. It then follows that global marketing takes a more standardized approach to world markets and focuses upon sameness, in other words the similarities in consumers and segments. So lets take a look at some generally accepted definitions. At its simplest level, international marketing involves the firm in making one or more marketing mix decisions across national boundaries. At its most complex level, it involves the firm in establishing manufacturing facilities overseas and coordinating marketing strategies across the globe. So, as with many other elements of marketing, there is no single definition of international marketing, and there could be some confusion about where international marketing begins and global marketing ends. These lessons will assume that both terms are interchangeable, and will define international marketing as follows: International marketing is simply the application of marketing principles to more than one country. The process of globalisation also provide a country to have a hidden attack to another. International marketing is often not as simple as marketing your product to more than one nation. Companies must consider language barriers, ideals, and customs in the market they are approaching. Tailoring your marketing strategies to attract the specific group of people you are attempting to sell to be highly important and can serve the number one cause of failure or success. International Trade to International Marketing Originally, the producers used to export their products to the nearby countries and gradually extended the exports to far-off countries. Gradually, the companies extended the operations beyond trade. For example India used to export raw cotton, raw jute and iron ore during the early 1900s. The massive industrialization in the country enabled us to export jute products, cotton garments and steel during 1960s. India, during 1980s could create markets for its products, in addition to mere exporting. The export marketing efforts include creation of demand for Indian products like textiles, electronics, leather products, tea, coffee etc., arranging for appropriate distribution channels, attractive packaging, product development, pricing etc. This process is true not only with India, but also with almost all developed and developing economies.
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International Marketing to International Business The multinational companies which were producing the products in their home countries and marketing them in various foreign countries before 1980s, started locating their plants and other manufacturing facilities in foreign/ host countries. Later, they started producing in one foreign country and marketing in other foreign countries. For example Uni Lever established its subsidiary company in .India, i.e., Hindustan Lever Limited (HLL). HLL produces its products in India and markets them in Bangladesh, Sri Lanka, Nepal etc., Thus, the scope of the international trade is expanded into international marketing and international marketing is expanded into international business. The 1990s and the new millennium clearly indicate rapid internationalization and globalization. The entire globe is passing at a dramatic pace through the transition period. Today, the international trader is in a position to analyze and interpret the global, social, technical, economic, political and natural environmental factors more clearly. Figure 1.1 presents international business model consisting influencing environmental factors, stages, approaches, and modes of entry, goals of and advantages of international business)
Figure 1: International Business Model
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Declining Trade Barriers
Another significant driver of globalization is the declining trade barriers. International trade occurs when the goods flow across the countries. Governments used to impose trade barriers like quotas and tariffs in order to protect domestic business from the competition of international business. Advanced countries after World War II agreed to reduce tariffs in order to encourage free flow of goods. The member countries of the General Agreement on Trade and tariff (GAIT) in various rounds of negotiations agreed to reduce the tariff rates. The Uruguay round of negotiations contributed to further reduction of trade barriers and extension of GAIT to cover manufactured goods and services. Consequently, the USA reduced the rate of tariffs from 44% in 1913 to 14% in 1950, to 4.8% ill 1990 and further t03.9% in 2000. Similarly, Japan reduced the rate of tariff from 30% in 1913 to 5.3% in 1990 and to 3.9%in 2000. Thus, most of the advanced countries reduced the tariff rates to 3.9% in 2000. The growth of international trade between 1950.and 2007 was about 28-fold. These reductions in tariff and other trade barriers contributed for the growth of global trade. Declining Investment Barriers Global business firms invest capital in order to establish manufacturing and other facilities in foreign countries. Foreign governments impose barriers on foreign investment in order to protect domestic industry but various countries have been removing these barriers on foreign direct investment in order to encourage the growth of global business. Various governments made 1,238 changes in the laws governing foreign direct investment between 1991 and 2007. Out of these amendments, 95% were in favour of foreign direct investment. In addition, bilateral treaties increased from 181 as of 1980 to 1,856 as of 2000 among 160 countries. These treaties, which were designed to promote and protect investment among countries, enabled the fast growth of globalization of not only trade, but also production. Consequently, the global production increased.
1.4 Multinational Enterprises

A multinational corporation/company is an organization doing business in more than one country. Transnational company produces, markets, invests and operates across the world. MNCs and TNCs have been growing and spreading their operations due to market, financial and other superiorities and the expansion of international markets. Growth of Multinational Enterprises The European Union had l63 out of 500 top MNCs in the world in 2007 followed by USA (162) and Japan (67). Developing countries had around 53 MNCs among the top 500 MNCs in the world in 2007. In fact, MNCs of developing countries have been increasing in contrast to that of developed countries. India had six MNCs among the top 500 MNCs.
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Influences of International Business Conducting and managing international business operations is a crucial venture due to variations in political, social, cultural and economic factors, from one country to another country. For example, most of the African consumers prefer less costly products due to their poor economic conditions, whereas the German consumers prefer high quality and high priced products due to their higher ability to buy. Therefore, the international businessman should produce and export less costly products to most of the African countries and vice versa to most of the European and North American countries. High priced and high quality Palmolive soaps are marketed in European countries and the economy priced Palmolive soaps are exported and marketed in developing countries like Ethiopia, Pakistan, Kenya, India, Cambodia etc. Characteristic features of international business include: Accurate Information: International business houses need accurate information to make an appropriate decision. Europe was the most opportunistic market for leather goods and particularly for shoes. Bata based on the accurate data could make appropriate decisions to enter various European countries. Timely Information: International business houses need not only accurate but timely information. Coca-Cola could enter the European market based on the timely information, whereas Pepsi entered later. Another example is the timely entrance of Indian software companies into the US market compared to those of other countries. Indian software companies also made timely decision in the case of Europe. Size of the Business: The size of the international business should be large in order to have an impact on the foreign economies. Most of the multinational companies are significantly large in size. In fact, the capital of some of the MNCs is greater than our annual budget and GDPs of the some of the African countries. Market Segmentation: Most of the international business houses segment their markets based on the geographic market segmentation. Daewoo segmented its market as North America, Europe, Africa, Indian sub-continent and Pacific markets.
Stages of international business are The above stated factors contributed for the significant change in the scenario of international business and resulted in the variations in the operations of international companies. These variations in the scenarios generally categorized into five stages viz., domestic company. Now, we study each scenario in detail. Stage 1: Domestic Company Domestic company limits its operations, mission and vision to the national political boundaries. This company focuses its view on the domestic market opportunities, domestic suppliers, domestic financial companies, domestic customers etc.
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These companies analyze the national environment of the country; formulate the strategies to exploit the opportunities offered by the environment. The domestic companies unstated motto is that, if it is not happening in the home country, it is not happening. The domestic company never thinks of growing globally. If is grows, beyond its present capacity, the company selects the diversification strategy of entering into new domestic markets, new products, technology etc. The domestic company does not select the strategy of expansion/penetrating into the international markets. Stage 2: International Company Some of the domestic companies, which grow beyond their production and/or domestic marketing capacities, think of internationalizing their operations. Those companies who decide to exploit the opportunities outside the domestic country are the stage two companies. These companies remain ethnocentric or domestic country oriented. These companies believe that the practices adopted in domestic business, the people and products of domestic business are superior to those of other countries. The focus of these companies is domestic but extends the wings to the foreign countries. These companies select the strategy of locating a branch in the foreign markets and extend the same domestic operations into foreign markets. In other words, these companies extend the domestic product, domestic price, promotion and other business practices to the foreign markets. Normally internationalization process of most of the global companies starts with this stage two processes. Most of the companies follow this strategy due to limited resources and also to learn from the foreign markets gradually before becoming a global company without much risk. The international company holds the marketing mix constantly and extends the operations to new countries. Thus, the international company extends the domestic country marketing mix and business model and practices to foreign countries. Stage 3: Multinational Company Sooner or later, the international companies learn that the extension strategy (i.e., extending the domestic product, price and promotion to foreign markets) will not work. The best example is that Toyota exported Toyota cars produced for Japan in Japan to the USA in 1957. Toyota was not successful in the USA. Toyota could not sell these cars in the USA as they were overpriced, underpowered and built like tanks. Thus, these cars were not suitable for the US markets. The unsold cars were shipped back to Japan. Toyota took this failure as a rich learning experience and as a source of invaluable intelligence but not as failure. Toyota based on this experience designed new models of cars suitable for the US market. The international companies turn into multinational companies when they start responding to the specific needs of the different country markets regarding product, price and promotion.
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This stage of multinational company is also referred to as multi-domestic. Multi-domestic company formulates different strategies for different markets; thus, the orientation shifts from ethnocentric to polycentric. Under polycentric orientation the offices/branches/subsidiaries of a multinational company work like domestic company in each country where they operate with distinct policies and strategies suitable to the country concerned. Thus, they operate like a domestic company of the country concerned in each of their markets. Philips of Netherlands was a multi domestic company of this stage during 1960s. 1t used to have autonomous national organizations and formulate the strategies separately for each country. Its strategy did work effectively until the Japanese companies and Matsushita started competing with this company based on global strategy. Global strategy was based on focusing the company resources to serve the world market. Philips strategy was to work like a domestic company, and produces a number of models of the product. Consequently, it increased the cost of production and price of the product. But the Matsushitas strategy was to give the value, quality, design and low price to the customer. Philips lost its market share as Matsushita offered more value to the customer. Consequently, Philips changed its strategy and created industry main groups in Netherlands which are responsible for formulating a global strategy for producing, marketing and R & D. Stage 4: Global Company A global company is the one, which has either global marketing strategy or a global strategy. Global company either produces in home country or in a single country and focuses on marketing these products globally, or produces the products globally and focuses on marketing these products domestically. Harley designs and produces. Super heavy weight motorcycles in the USA and markets .in the global market. Similarly, Dr. Reddys Lab designs and produces drugs in India and markets globally. Thus, Harley and Dr. Reddys Lab are examples of global marketing focus. Gap procures products in the global countries and markets the products through its retail organization in the USA, Thus, Gap is an example for global sourcing company. Harley Davidson designs and produces in the USA and gains competitive advantage as Mercedes in Germany. The Gap understands the US consumer and gets competitive advantage. Stage 5: Transnational Company Transnational company produces, markets, invests and operates across the world. It is an integrated global enterprise that links global resources with global markets at profit. There is no pure transnational corporation. However, most of the transnational companies satisfy many of the characteristics of a global corporation. For example Coca-Cola Pepsi Cola etc.
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Differences between Domestic Business and International Business Basically, domestic business and international business operate on similar lines. But there are certain differences between these two businesses. The significant differences between these two emerge from foreign exchange, quotas, tariff, regulations of a number of governments, wide variations in culture and the like. Table presents the differences between domestic business and international business. Difference between Domestic Business and International Business
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Modes of Entry When a domestic company plans to engage in international business, the company has to select the mode of entry into the foreign country based on all relevant factors like the size of business, influence of environmental factors, attractiveness of the foreign market, market potential Costs and benefits and risk factors. Different modes of entry to foreign markets include Direct Exporting Indirect Exporting Licensing arrangements with foreign companies Franchising arrangements with foreign companies Contract manufacturing Management contracts Turn Key projects Direct Investment Joint Ventures Mergers and Acquisitions
Advantages of International Business: We shall discuss the competitive advantages of international business. High Living Standards: Comparative cost theory indicates that the countries which have the advantage of raw materials, human resources, natural resources and climatic conditions in producing particular goods can produce the products at low cost and also of high quality. Customers in various countries can buy more products with the same amount of money. In turn, it can also enhance the living standards of the people through enhanced purchasing power and by consuming high quality products. Increased Socio-Economic: Welfare: International business enhances consumption level, and economic welfare of the people of the trading countries. For example, the people of China are now enjoying a variety of products of various countries than before as China has been actively involved in international business like Coca-Cola, McDonalds range of products, electronic products of Japan and coffee from Brazil. Thus, the Chinese consumption levels and socioeconomic welfare are enhanced.
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Wider Market: International business widens the market and increases the market size. Therefore, the companies need not depend on the demand for the product in a single country or customers tastes and preferences of a single country. Due to the enhanced market the Air France, now, mostly depends on the demand for air travel of the customers from countries other than France. This is true in case of most of the MNCs like Toyota, Honda, Xerox and Coca-Cola. Reduced Effects of Business Cycles: The stages of business cycles vary from country to country. Therefore, MNCs shift from the country, experiencing a recession to the country experiencing boom conditions. Thus, international business firms can escape from the recessionary conditions. Reduced Risks: Both commercial and political risks are reduced for the companies engaged in international business due to spread in different countries. Multinationals which were operating in erstwhile USSR were affected only partly due to their safer operations in other countries. But the domestic companies of the then USSR collapsed completely. Large-Scale Economies: Multinational companies due to the wider and larger markets produce larger quantities, which provide the benefit of large-scale economies like reduced cost of production, availability of expertise, quality etc. Potential Untapped Markets: International business provides the chance of exploring and exploiting the potential markets which are untapped so far. These markets provide the opportunity of selling the product at a higher price than in domestic markets. For example, Bata sells shoes in the UK at 100 (Rs. 8,000) whose price is around Rs. 1,200 in India. Provides the Opportunity For and Challenge to Domestic Business: International business firms provide the opportunities to the domestic companies. These opportunities include technology, management expertise, market intelligence, product developments etc. For example, Japanese firms operating in the L provide these opportunities to the LS companies. This is more evident in the case of developing countries like India, African countries and Asian countries. Similarly, the MNCs pose challenges to the domestic business initially. Domestic firms develop themselves to meet these challenges. Thus, the opportunities and challenges help the domestic companies to develop. Maruti helped Telco to come up with Tata Indica. Foreign Universities helped IMs, ITs and Indian Universities to enhance their curricula. Division of Labour and Specialization: As mentioned earlier, international business leads to division of labour and specialization. Brazil specializes in coffee, Kenya in tea, Japan in. automobiles and electronics, India in textile garments etc. Economic Growth of the World: Specialization, division of labour enhancement of productivity, posing challenges, development to meet them, innovations-and creations to meet the competition lead to overall economic growth of the world nations. International business particularly helped
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the Asian countries like Japan, Taiwan, Korea, Philippines, Singapore, Malaysia, and the United Arab Emirates. Optimum and Proper Utilization of World Resources: International business provides for the flow of raw materials, natural resources and human resources from the counties where they are in excess supply to those countries which are in short supply or need most. For example, flow of human resources from India, consumer goods from the UK, France, Italy and Germany to developing countries. This, in turn, helps in the optimum and proper utilization of world resources. Cultural Transformation: International business benefits are not purely economical or commercial; they are even social and cultural. These days, we observe that the West is slowly tending towards the East and vice versa. It does mean that the good cultural factors and values of the East are acquired by the West and vice versa. Thus, there is a close cultural transformation and integration. Knitting the World into a Closely Interactive Traditional Village: International business, ultimately knits the .global economies, societies and countries into a closely interactive and traditional village where one is for all and all are for one.
Problems of International Business As is said that, life is not a bed of roses, international business is not all that lovely. It has its problems. The important problems include: Political Factors: Political instability is the major factor that discourages the spread of international business. For example, in the Iran-Iraq war, Iraq-Kuwait war, dismantling of erstwhile USSR, Civil Wars in Fiji, Malaysia, and Sri Lanka, military coups in Pakistan, Afghanistan, frequent changes of political parties in power and thereby changes in government policies in India etc., created political risks for the growth of international business. Also, Indo-Pak Summit at Agra in July, 200 1 ended in a no compromise situation, which affected international business. Though there are political problems between India and China, business houses of these two countries have developed opportunities for Indo-China business relations, In fact, these two countries are also working in this direction. Huge Foreign Indebtedness: The developing countries with less purchasing power are lured into a debt trap due to the operations of MNCs in these countries. For example, Mexico, Brazil, Poland, Romania, Kenya, Congo, and Indonesia. Exchange Instability: Currencies of countries are depreciated due to imbalances in the balance of payments, political instability and foreign indebtedness. This, in turn, leads to instability in the exchange rates of domestic currencies in terms of foreign currencies. For example. Zambia, India, Pakistan, Philippines depreciated their currencies many times. This factor discourages the growth of international business
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Entry Requirements: Domestic governments impose entry requirements to multinationals. For example, An MNC can enter Eritrea only through a joint-venture with a domestic company. However, with the establishment of World Trade Organization (WTO), many entry requirements by the host governments are dispensed with. Tariffs, Quotas and Trade Barriers: Governments of various countries impose tariffs, import and export quotas-and trade barriers .in order to protect domestic business. Further, these barriers are imposed based on the political and-diplomatic relations between or among Governments. For example, China, Pakistan and the USA (before 1998) imposed tariffs, quotas and barriers on imports from India. But the erstwhile USSR and present Russia liberalized imports from India. Corruption: Corruption has become an international phenomenon. The higher rate bribes and kickbacks discourage the foreign investors to expand their operations. Bureaucratic Practices of Government: Bureaucratic attitudes and practices of Government delay sanctions, granting permission and licenses to foreign companies. The best example is Indian Government before 1991. Technological Pirating: Copying the original technology, producing imitative products, imitating other areas of business operations were common in Japan during 1950s and 1960s, in Korea, India etc. This practice invariably alarms the foreign companies against expansion. Quality Maintenance: International business firms have to meticulously maintain quality of the product based on quality norms of each country. The firms have to face server consequences, if they fail to conform to the country standards. Consumers forums/ associations also inspect quality in addition to the government machinery in various foreign countries.
1.5 International Trade Theories

The well known International trade theories can be classified as: Theory of Mercantilism Theory of Absolute Advantage Theory of Absolute Cost Advantage Theory of Comparative Advantage Theory of Comparative Cost Advantage Heckscher-Ohlin Theory Leontief Paradox
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Product Life Cycle Theory Porters Diamond Model
Common sense suggests that some international trade is beneficial for all. Writing in his famous book, The Wealth of Nations, in 1776, Adam Smith argued that trade is beneficial because of differences between countries in the costs of producing different goods. Like all of his contemporaries, Smith held to a labour theory of value, according to which the cost of producing a good was given by the labour time required to produce it. Therefore, the differences in the costs of producing a certain good in different countries reflected differences in labour efficiencies in each country. However, rather than each country striving to produce all the products which they could, each should concentrate on those products in which they enjoy a cost advantage over other countries (core competencies of each country) The result will be that all are better off. To see this, consider a simple numerical example of the kind used by Smith to illustrate this principle. Imagine two countries, A and B, which possess identical labour resources which they divide equally between the two activities, cloth and rice. The following figure give the amount (units) of the two goods which each country is able to produce if all its workers are fully employed.
Clearly, A is more efficient at producing rice and B at cloth. Therefore, pays f: to specialize in rice and B in cloth. Hence, A switches all its resources into rice and B into cloth. In that case, situation may emerge as shown in the following table:
1.5.1 Theory of Mercantilism

The doctrine of mercantilism propagates in the 16th and 17th centuries, advocated that countries should simultaneously encourage exports and discourages imports. Mercantilism was premised on the notion that .exports are per se good because they earn a country gold, while imports are per se bad because
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they result in an outflow of gold. (In those days, gold was the currency normally used to finance trade.) Consequently, a country should strive to reduce its dependence on imports by producing as much as it could itself. In practical terms, it suggested that the government policy should seek to reduce imports by imposing duties on imports and restricting the amount of foreign goods that are allowed into the country. At the same time, every effort should be made to boost exports by whatever means. If one country succeeds in achieving a large export surplus, it can only do so if other countries run an equivalent trade deficit. It follows that, if all countries pursue such a policy, the result will be conflict among them. Either one country will succeed at the expense of the rest or else all will fail to achieve their objective. Divided Government and US Trade Policy Theory and Evidence If different parties control the US Congress and White House, the United States may maintain higher import protection than otherwise. This proposition follows from a distributive politics model in which Congress can choose to delegate trade policymaking to the President. When the congressional majority party faces a President of the other party, the former has an incentive to delegate to but to constrain the President by requiring congressional approval of trade proposals by up-or-down vote. This constraint forces the President to provide higher protection in order to assemble a congressional majority. Evidence confirms that (i) the institutional constraints placed on the Presidents trade policymaking authority are strengthened in times of divided government and loosened under unified government and (ii) US trade policy was significantly more protectionist under divided than under unified government during the period 1949-90. In the mid 16th century, gold and silver was the mainstay of national health and essential for commerce. A country could earn gold and silver by exporting goods and in the same way importing of goods resulted in the outflow of gold and silver. The main tenet of mercantilism was that it was in the countries best interest to maintain a trade surplus, to export more than import. In doing so a country could accumulate more gold and silver and, consequently its national wealth and prestige.
1.5.2 Theory of Absolute Advantage

This theory propounded by Adam Smith in 1776, states that a country has an absolute advantage in the production of an item when it is more efficient than any other country in producing it. Smith attacked the mercantilist assumption and argued that countries differ in their ability to produce goods efficiently. In his time, the British, by virtue of their superior manufacturing process, were the worlds most efficient textile manufacturers. French had the worlds most efficient wine industry due to favourable climate, good soils and accumulated expertise, i.e., the Britain had an absolute advantage in the production of textiles, while the French had an absolute advantage in the production of wine. The easiest explanation for trade is the concept of absolute advantage. Mexico exports petroleum to Japan. USA exports
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airplanes to Sweden. These examples illustrate the principle called absolute advantage wherein the exporting company holds superiority in the availability and the cost of certain goods. Absolute advantage may come due to factors of climate, quality of land and natural resource endowments or difference in labour, capital, technology and entrepreneurship. Some nations have oil and some dont have. It appears sensible for each country to specialize in the product in .which has an absolute advantage and secure its needs of the product in which it has a disadvantage through trade.
1.5.3 Theory of Absolute Cost Advantage

Adam Smith was a leading advocate of free trade on the ground that it promoted the international division of labour or territorial specialization. Trade occur; between countries because production possibilities of the different countries are different. The factors influencing production possibilities can be climate, so^ mineral wealth which give certain nations natural advantages in certain production It could also differ because of acquired advantages like special skills and technique; in production. Smiths concept of cost was based on labour theory of value. The two basis assumptions of the theory are: (i) Labour is the only factor of production and it is homogeneous. (if) The cost of a good depends only upon the amount of labour required to produce it. Smiths trading principle was the principle of absolute cost advantage. In the two-country two-commodity world, international trade and specialist-will be beneficial when a nation has an absolute cost advantage in one good and that other nation in the other good. Absolute cost advantage is measured in terms or labour hour employed in one unit of output. A nation is said to have absolute advantage in the production of a commodity when it uses lesser labour hour per unit of output than the other nation. A nation will import those goods in which it has absolute cost disadvantage and export those goods in which it has absolute cost advantage.
1.5.4 Theory of Comparative Advantage

Trade based on absolute advantage is easy to understand. But what happens when one country can produce all products with an absolute advantage? Would trade occur? Can trade still be mutually advantageous to the trading partners? Here we encounter the doctrine of comparative advantage first introduced b David Ricardo m the early 19th century. The doctrine emphasizes relative rather than absolute cost differences. The doctrine demonstrates that .mutually advantageous trade can occur even when one trading partner has absolute
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advantage. It makes sense for a country to specialize in the production of those goods that it produces less efficiently from other countries. This theory stresses that comparative advantage arises from differences in productivity. Ricardo focused on labour productivity and .argued that differences in labour .productivity between nations underline the notion of comparative advantage. Thus, whether French .1S mo.re efficient than British in the production of wine depends on how, productively it uses 1tS resources. .
1.5.5 Theory of Comparative Cost Advantage

Comparative cost advantage theory of international trade was developed by dr British economists in the early 19th century. In the year 1817 David Ricar published his Political Economy-and Taxation in which he presented the La, Comparative cost Advantage. As in the absolute cost advantage theory, this: -also says that international trade is solely due to differences in the productivity a labour in different countries. Absolute cost advantage theory can explain only a very small part of world trade such as trade between tropical zone and tempera* zone or between developed countries and developing countries. Most of the work trade is between developed countries that are similar with respect to their resource and development which is not explained by absolute cost advantage. The basis for such trade can be explained by the law of comparative advantage. Assumptions of the Ricardian Theory We can begin the analysis by listing the number of assumptions required to build the theory: 1. 2. Each country has a fixed endowment of resources and all units of eac4 particular resource are identical. The factors of production are perfectly mobile between alternate productions within a country. This assumption implies that the prices factors of production are also the same among alternative uses. Factors of production are completely immobile between countries. Labour theory of value is employed in the model. The relative value for commodity is measured solely by its relative labour content. Countries use fixed technology though there may be different technologies in different countries. The simple model assumes that production is under constant case conditions regardless of the quantity produced. Hence the supply curve for any good is horizontal. There is full employment in the macro-economy. The economy is characterized by perfect competition in the product of the market. There is no governmental intervention in the form of restrictions to for trade.
3. 4. 5. 6. 7. 8. 9.
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10. In the basic model, transport costs are zero. 11. It is a two-country, two-commodity model.
Table 1: Illustration of Comparative Cost Advantage Table 1 show that country A has absolute cost advantage in the production of both the commodities. This is shown by lesser labour hours required in the production of cloth and wine which is 1 hour per unit of cloth and 3 hours per unit of wine. This is lesser than 2 hours per unit of cloth and 4 hours per unit of wine as required in country B. Even then trade between the two countries can be mutually advantageous so long as the difference in comparative advantage exists between the productions of two commodities. The example shows that country A is twice as productive as country B in cloth production whereas in wine production it is only 4/3 times as productive as the country B. Hence country A has higher comparative advantage in cloth production. Country B has comparative advantage in wine because its relative inefficiency is lesser in wine. It is half as productive in cloth while in wine the difference in labour productivity is only 1/3 minus 1/4, which is much less than 1/2. International trade is mutually profitable even when one of the countries can produce every commodity more cheaply than the other. Each country should specialize in the product in which it has a comparative advantage that is greatest relative efficiency. When trade takes place between the two countries, the terms of trade will be within the limits set by the internal price ratio before trade. For both countries to gain, the terms of trade should be somewhere between the two countries internal price ratios before trade. Country A gains by getting more than one unit of wine for every 3 units of cloth and country B gains by getting something more than 2 units of cloth for every one unit of wine. The actual terms of trade will depend upon comparative strength of elasticity of demand of each country for the others product. Illustration with Production Possibility Frontiers Production Possibility Frontier (PPF) reflects all combination of the two products that the country can produce under certain conditions. These conditions are: 1. 2. 3. The total resources are finite and known. The resources are fully employed. The technology is given.
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4. 5.
The production is economically efficient, that is with the least cost combination of inputs. The costs are constant implying opportunity cost is the same at various levels of production. PPF is hence a straight line whose slope is given by opportunity cost of one product in terms of the other.
Country As resources are given at 18,000 labour hours with price ratio of 1 unit wine: 3 units of cloth. Country A can produce either 18,000 units of cloth and 0 units of wine or 6,000 units of wine and 0 units of cloth.
Table 2: Gains from trade with terms of trade Under the assumed trade price ratio of 1: 2.5 between wine and cloth, the total gain is 400 units of wine for country A and 3,000 units of cloth for country B. The gain for individual countries will differ depending upon the trade price ratio. However, the point remains that both the countries gain from trade. Criticisms of the Assumptions of Ricardian Theory 1. Two X Two model. Ricardian theory of comparative advantage is based on the assumptions of two commodities and two countries. This is not a serious limitation and is made purely for simplifying the exposition of the theory. The principle behind the theory holds good even when more than two countries and more than two commodities are involved. However generalizing the analysis to cover many countries and many commodities at the same will make the treatment cumbersome and difficult. Constant costs. Assumption regarding constant cost conditions will lead to complete specialization. When this is relaxed to consider increasing cost conditions, the principle of
2.
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comparative advantage may not lead to complete specialization but to a situation of partial specialization. In that case countries will specialize in the commodity in which they have a comparative advantage but nevertheless will produce the other commodity also. 3. No transport cost. Absence of transport cost in determining comparative advantage is again not a crucial assumption. Even when this assumption is relaxed the theory will hold good. The costs can be redefined to include transport cost and comparative advantage can be assessed on the basis of such costs. Of course this will reduce the scope for the presence of comparative advantage in many commodities for many countries and this explains why every country has a lot of non-traded commodities. Trade restrictions. Though in the real world absence of government intervention in the form of protective tariff on quota is hard to find, such restrictions definitely reduce scope for free trade on the basis of comparative advantage. Labour theory of value. Ricardian theory is basically criticized for one main reasonthat it is based on labour theory of value. This limitation has been removed by later theories of international trade. For example, Haberler uses concept of opportunity cost and shows how difference in opportunity cc: production between countries forms the basis of international trade. Emphasis on supply. Ricardian theory clearly shows that free trade res in mutual benefit for the trading countries. However, it does not show the e:\ terms of trade between the two commodities traded which will determine the e>r of the respective gains from trade. Ricardo emphasizes the supply side factors determinants of basis for trade. It was left to Mill to introduce the demand factor in determining the terms of trade between countries. Changes in tastes and differences. Ricardian theory does not explain possibility of trade occurring because of differences in tastes and prefer between people in two countries. Nations can have commodities with lower the price because of lower domestic demand and not because of higher lat. productivity. Here comparative advantage is not because of lower labour cost.
4.
5.
6.
7.
Heckscher-Ohlin Theory (Modem Theory of International Trade) Swedish economists Eli Heckscher (in 1919) and Bertil Ohlin (in 1933) put forward .theory of comparative advantage. According to their theory, the comparative advantage of a country arises from differences in national factor endowment. Factors of endowment mean the extent to which a country is endowed with resources like land, labour and capital. Nations have various factors of endowment and different factors of endowment explain difference in factor of cost. Heckscher-Ohlin theory predicts that countries will export those goods .that make intensive use of factors that are locally abundant, while importing goods that make use of factors that are locally scarce. Heckscher-Ohlin theory also has a commonsense appeal. For example, the United States has long
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been a substantial exporter of agricultural goods reflecting in parts its unusual abundance of arable land. In contrast, China excels in the export of goods produced in labour intensive manufacturing industries, such as textiles and footwear. This reflects Chinas relative abundance of low labour cost. The United States, which lacks abundance of low labour cost, has been a primary importer of these goods. Note that it is relative, not absolute endowments that are important for example, export of human resources from India, being a labour abundant country. Similarly, China excels in the export of goods produced in labour intensive industries. The Leontief Paradox Using Heckscher-Ohlin theory, Wassily Leontief (Winner of the Noble Prize in economics in 1973) postulated that since United States was relatively abundant of capital compared to other nations, the United States would be an exporter of capital intensive goods and an importer of labour intensive goods. To his surprise, however, he found that US exports were less capital intensive than US imports. Since this result was at variance with the prediction of the theory, it has become known as the Leontief paradox. One possible explanation is that United States has a special advantage in producing new products or goods made with innovative technologies. Such products may be less capital intensive than products whose technology has had time to mature and become suitable for mass production. Thus, the United States must be exporting goods that heavily use skilled labour and innovative entrepreneurship, such as computer software, while importing heavy manufacturing products that use large amounts of capital. One might also argue that United States exports commercial aircraft and imports automobiles not because its factor endowments is especially suited to aircraft manufacture and not suited to automobile manufacture, but because United states is more efficient in producing aircraft than automobiles.
1.6 The Product Life Cycle Theory

Raymond Vernon proposed the product life cycle theory in the mid 1960s. His observation was that large proportions of the new products were developed by US firms and sold in US market, e.g. Televisions, instant cameras, photocopiers, personal computers, etc. Vernon argued that most new products were initially produced in the United States. Apparently the pioneering firms believed that it is better to keep production facilities close to the market and the firms centre of decision making, given the risk inherent in introducing new products. Also, the demand for most new products tends to be based on non price factors. Vernon argued that early in the life cycle of typical new product, while demand is starting to grow in the United States, demand in other advanced countries is limited to the high income groups. Therefore, the limited initial demand does not necessitate the country to start producing the product but it is required to be exported from the United States.
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Over time, the demand for the product increases. As it does, it becomes worthwhile for the country to start producing the product. In addition, US might set up their production facilities in those countries where the product demand is growing. Consequently, the production within other advanced countries begins to limit the potential for exports from the United States. As the market for the product matures in other advanced countries and the United States, the product becomes more standardized, and price becomes the main competitive weapon. Producers based in other countries, where labour cost is low, might now be able to export the product to the United States. If the cost pressure becomes intense, the process might not stop here. The cycle by which United States lost its advantage to other advanced countries may be repeated once more, as developing countries begin to acquire a production advantage over the advanced countries. Thus, the locus of global production initially switches from the United States to other advanced countries and then from those countries to developing countries. The consequences of these trends for the pattern of world trade is that overtime the United States switches from being an exporter to an importer of the product as production gets concentrated in the lower cost foreign locations.
Table 3: Product Life Cycle theory Example for Product Life Cycle Theory Let us take the case of photocopiers, the product was first developed in the early 1960s by Xerox in the United States and sold initially, Xerox exported photocopy machines from US, primarily to Japan and the advanced countries. As demand began to grow in foreign countries, Xerox entered into joint ventures to set up production in Japan (Fuji-xerox), India (Modi-xerox), etc. As a consequence, exports from US declined, and the US users started importing some of their photocopiers from lower-cost foreign countries, particularly Japan. This evolution in the pattern of foreign trade is consistent with the product life cycle theory.
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Mature industries tend to go out of own country and into low-cost assembly locations. National Competitive Advantage: Porters Diamond Model Michael Porter is a famous Harvard business professor. He conducted a comprehensive study of 100 industries in 10 nations to learn why do some nations succeed in international competition? Porter introduced this model in book: The Competitive Advantage of Nations. He sought to explain why a nation achieves success in a particular industry. Why Indians did well in the software industry? Why are Japanese doing well in the automobile industry? Both Heckscher-Ohlin theory and Theory of Comparative Advantage is only partly able to explain. According to Porter, a nation attains a competitive advantage if its firms are competitive. Firms become competitive through innovation. Innovation can include technical improvements to the product or to the production process. Porter hypothesizes that four broad attributes of a nation that (Figure 1) shape the environment in which local firms compete. The quality of this competition promotes or impedes the creation of global competitive advantage. These four attributes constitute Diamond. They are:
Figure 2: Porters Diamond Model for the Competitive Advantage of Nations a) b) Factor conditions (i.e., the nations endowments in factors of production, such as skilled labour and infrastructure necessary to compete in a given industry) Demand conditions (i.e., sophisticated customers in home market)
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c) d)
Related and supporting industries (which are internationally competitive) Firm strategy, structure and rivalry (i.e., conditions governing creation, organization, management of companies, and the nature of domestic rivalry)
Factor Conditions and Endowments Factor conditions refer to inputs used as factors of production such as labour, I d, natural resources, capital and infrastructure. Porter classified the factors of production as key (advanced or specialized) factors and non-key (basic) factors. Porter argues that the key factors of production (or specialized factors) are created, not inherited. Specialized factors of production are skilled labour, capital and infrastructure. Non-key factors or general use factors, such as unskilled labour and raw materials, can be obtained by any company and, hence, do not generate sustained competitive advantage. However, specialized factors involve heavy, sustained investment. This leads to a competitive advantage, because other firms cannot easily duplicate these factors. For example, development of KPO industry ill India is on account of key factors like information infrastructure and hugely talented human resources. The relationship between key and non-key factors is complex, Natural resources, climate etc. fall under non-key factors whereas communication infrastructure, research facilities, etc. are classified as key (advanced) factors Non-key factors provide an initial advantage which is subsequently reinforced and extended by investment in specialized factors. Conversely, disadvantages basic factors can create pressures to invest in advanced factors. Porter argues that a lack of resources often actually helps countries to become competitive called Selected Factor Disadvantage (SFD). Abundance generates waste and scarcity generates an innovative mindset. Such countries are forced to innovate to overcome their problem of scarce resources. a) b) Switzerland was the first country to experience labour shortages. They abandoned labourintensive watches and concentrated on innovative/] high-end watches. Japan has high priced land and so its .factory space is at premium. This lead to just-in-time inventory techniques (Japanese firms cant have a lot of stock taking up space, so to cope with the potential of not have goods around when they need it, they innovated traditional inventory techniques).
Demand Conditions As per Porters model, a sophisticated domestic market is an important element to achieve international competitiveness. The firms that have demanding consumers are likely to sell superior products because the market demands high quality. Such consumer enables the firm to better understand the needs and desires of the customers, for example,
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i.
Sophisticated and demanding customers helped push Nokia of Finland and Ericsson of Sweden to invest hugely in cellular phone technology. On account of this, these two firms are dominant players in the global cellular technology. Japans knowledgeable buyers helped stimulate their camera industry to introduce innovative models.
ii.
Related and Supporting Industries This is one .of the most pervasive findings of Porters study. He says that a set of strong related and supporting industries is important to the competitiveness of firms. This includes presence of suppliers and related industries. This usually occurs at a regional level as opposed to a national level. Examples include Silicon Valley in US, and Italy (leather-shoes-other leather goods industry). The phenomenon of competitors (and upstream and/or downstream industries) locating in the same area is known as clustering or agglomeration. When there is a large industry presence in an area, it will increase the Supply of specific factors (i.e., workers with industry-specific training). At the same time, upstream firms (i.e., those who supply intermediate inputs) will invest in the area. They will also wish to save on transport costs, tariffs, interfirm communication costs, inventories, etc. Downstream firms (i.e., those use industrys product as an input) will also invest in the area. This causes additional savings. Finally, attracted by the good set of specific factors, upstream and downstream firms, producers in related industries (i.e., those who use similar inputs or whose goods are purchased by the same set of customers) will also invest. This will trigger subsequent rounds of investment. Strategy, Structure and Rivalry Strategy and structure of the Countries with a short-run outlook (like US) will tend to be more competitive in industries where investment is short-term (like the-computer industry). Countries with a long run outlook (like Switzerland) w ill tend to be more competitive in industries where investment is long term (like the pharmaceutical industry). (Individuals base their career decisions on opportunities and prestige. A country will be competitive in an industry whose key personnel hold positions that are considered prestigious. Different nations are characterized by different management ideologies. For example, predominance of engineers in top management in Japanese and German firms. This has led to the emphasis on improving the product design and manufacturing. Whereas people with finance background are predominant in US leading to corresponding overemphasis on maximizing short term financial returns in US firms. Porter argues that the best management styles vary among industries. Some countries may be oriented toward a particular style of management. Those countries will tend to be more competitive in industries for which that style of management is suited. One consequence of dominance of finance in US has been relative loss of competitiveness in those engineering based industries (Automobile Industry in US is not
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internationally competent) where manufacturing process and design issues are very important. Rivalry, as per Porters model, there is strong association between vigorous domestic rivalry creation and persistence of competitive advantage. Intense competition spurs innovation resulting in improved efficiency. Rivalry induce firms to look for ways to improve efficiency, to reduce costs and to innovate For example, competition is particularly fierce in Japan, where many companies compete vigorously in most industries. The Diamond as a System Wherever the diamond is favourable, firms are most likely to succeed Porter argues that the diamond is a mutually reinforcing system. The effect of on attribute is contingent on the state of others, i.e., unless there is Inter firm rivalry, favourable demand conditions will not result in competitive advantage. The diamond promotes clustering/agglomeration.
Evaluating Porters Theory As per Porter, we should expect his model to predict the pattern of existing International Trade Countries should be exporting products from those industries wherever all the attributes of factor are favourable, while importing to those areas where the components are unfavourable. i. ii. Porter developed this paper based on case studies and these tend to only apply to developed economies. The Porter model does not adequately address the role of MNCs. There seems to be ample evidence that the diamond is influenced by factors outside the home country.
Implications of Trade Theories All these trade theories have implications on the business. The implications can be explained as follows: Strategy for locations is the most of the trade theories emphasize that due to different factors of production different countries have advantages in different productive activities. Hence it makes sense for the firm to disperse the production activities to countries having maximum efficiency. This global web of productive activities is used by the firms while going in for .globalization to get the competitive edge. Hence if design can be performed most efficiently in Germany, then this facility should be located there. Similarly, if the manufacturing is done most cheaply in India then the manufacturing facility should be located there. If the firm does not do it then it may find itself at competitive disadvantage relative to firms that do. Policy implementations in the firms are major players on the International trade scene since they do both import and export. The firms may tend to lobby to increase trade restriction or promote trade.
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However the International trade theories claim that free trade is good for the interest of country, although it may or may not be in the best interest of that particular firm. Porters theory also contains policy implications. It suggests that it is in the best interest of business for a firm to invest in upgrading advanced factors of production, i.e., to invest in better training and R&D. Infosys is one such firm, which has reaped immense benefit on account of this strategy. Thus, it makes ns that the firms lobby with the government to adopt policies which impact all components of Porter diamond favorably. The government therefore should increase investment in education, infrastructure, and basic research (all advanced factors). The government should also adopt policies which promote strong competition within domestic markets since this enable the firm to achieve international competitiveness.
1.7 Review Questions

1. 2. 3. 4. What is International Business and explain its characteristic features. Explain International Marketing, International Trade related to International Business. Explain the various theories associated to International Trade. Explain the various stages of International Business.
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Module II PLANNING AND ORGANISING THE HRD SYSTEM

Foreign Direct Investment Benefits of Documentation
2.1 Foreign Direct Investment (FDI)

A parent business enterprise and its foreign affiliate are the two sides of the FDI relationship. Together they comprise an MNC. The parent enterprise through its foreign direct investment effort seeks to exercise substantial control over the foreign affiliate company. Control as defined by the UN, is ownership of greater than or equal to 10% of ordinary shares or access to voting rights in an incorporated firm. For an unincorporated firm one needs to consider an equivalent criterion. Foreign direct investment (FDI) in its classic form is defined as a company from one country making a physical investment into building a factory in another country. It is the establishment of an enterprise by a foreigner. Its definition can be extended to include investments made to acquire lasting interest in enterprises operating outside of the economy of the investor. The FDI relationship consists of a parent enterprise and a foreign affiliate which together form an international business or a multinational corporation (MNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The IMF defines control in this case as owning 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm; lower ownership shares are known as portfolio investment.
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The foreign direct investor may acquire 10% or more of the voting power of an enterprise in an economy through any of the following methods: by incorporating a wholly owned subsidiary or company by acquiring shares in an associated enterprise through a merger or an acquisition of an unrelated enterprise participating in an equity joint venture with another investor or enterprise
Classification of Foreign Direct Investment Foreign direct investment may be classified as Inward or Outward. Foreign direct investment, which is inward, is a typical form of what is termed as inward investment. Here, investment of foreign capital occurs in local resources. The factors propelling the growth of Inward FDI comprises tax breaks, relaxation of existent regulations, loans on low rates of interest and specific grants. The idea behind this is that, the long run gains from such a funding far outweighs the disadvantage of the income loss incurred in the short run. Flow of Inward FDI may face restrictions from factors like restraint on ownership and disparity in the performance standard. Foreign direct investment, which is outward, is also referred to as direct investment abroad. In this case it is the local capital, which is being invested in some foreign resource. Outward FDI may also find use in the import and export dealings with a foreign country. Outward FDI flourishes under government backed insurance at risk coverage. Type of Foreign Direct Investors A foreign direct investor may be classified in any sector of the economy and could be any one of the following: an individual; a group of related individuals; an incorporated or unincorporated entity; a public company or private company; a group of related enterprises; a government body; an estate (law), trust or other societal organization; or any combination of the above.
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Determinants of Foreign Direct Investment One of the most important determinants of foreign direct investment is the size as well as the growth prospects of the economy of the country where the foreign direct investment is being made. It is normally assumed that if the country has a big market, it can grow quickly from an economic point of view and it is concluded that the investors would be able to make the most of their investments in that country. In case of foreign direct investments that are based on export, the dimensions of the host country are important as there are opportunities for bigger economies of scale, as well as spill-over effects. The population of a country plays an important role in attracting foreign direct investors to a country. In such cases the investors are lured by the prospects of a huge customer base. Now if the country has a high per capita income or if the citizens have reasonably good spending capabilities then it would offer the foreign direct investors with the scope of excellent performances. The status of the human resources in a country is also instrumental in attracting direct investment from overseas. There are certain countries like China that have taken an active interest in increasing the quality of their workers. They have made it compulsory for every Chinese citizen to receive at least nine years of education. This has helped in enhancing the standards of the laborers in China. If a particular country has plenty of natural resources it always finds investors willing to put their money in them. A good example would be Saudi Arabia and other oil rich countries that have had overseas companies investing in them in order to tap the unlimited oil resources at their disposal. Inexpensive labor force is also an important determinant of attracting foreign direct investment. The BPO revolution, as well as the boom of the Information Technology companies in countries like India has been a proof of the fact that inexpensive labor force has played an important part in attracting overseas direct investment. Infrastructural factors like the status of telecommunications and railways play an important part in having the foreign direct investors come into a particular country. It has been observed that if the infrastructural facilities are properly in place in a country then that country receives a substantial amount of foreign direct investment. If a country has extended its arms to overseas investors and is also able to get access to the international markets then it stands a better chance of getting higher amounts of foreign direct investment. It has been observed in the recent years that a couple of countries have altered their stance vis-a-vis overseas investment. They have reset their economic policies in order to suit the interests of the overseas investors. These companies have increased the transparency of the legal frameworks in place. This has been done so that the overseas companies can understand the implications of their investment in a particular country and take the appropriate decisions. Benefits of FDI One of the advantages of foreign direct investment is that it helps in the economic development of the particular country where the investment is being made.
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This is especially applicable for the economically developing countries. During the decade of the 90s foreign direct investment was one of the major external sources of financing for most of the countries that were growing from an economic perspective. It has also been observed that foreign direct investment has helped several countries when they have faced economic hardships. An example of this could be seen in some countries of the East Asian region. It was observed during the financial problems of 199798 that the amount of foreign direct investment made in these countries was pretty steady. The other forms of cash inflows in a country like debt flows and portfolio equity had suffered major setbacks. Similar observations have been made in Latin America in the 1980s and in Mexico in 1994-95. Foreign direct investment also permits the transfer of technologies. This is done basically in the way of provision of capital inputs. The importance of this factor lies in the fact that this transfer of technologies cannot be accomplished by way of trading of goods and services as well as investment of financial resources. It also assists in the promotion of the competition within the local input market of a country. The countries that get foreign direct investment from another country can also develop the human capital resources by getting their employees to receive training on the operations of a particular business. The profits that are generated by the foreign direct investments that are made in that country can be used for the purpose of making contributions to the revenues of corporate taxes of the recipient country. Foreign direct investment helps in the creation of new jobs in a particular country. It also helps in increasing the salaries of the workers. This enables them to get access to a better lifestyle and more facilities in life. It has normally been observed that foreign direct investment allows for the development of the manufacturing sector of the recipient country. Foreign direct investment can also bring in advanced technology and skill set in a country. There is also some scope for new research activities being undertaken. Foreign direct investment assists in increasing the income that is generated through revenues realized through taxation. It also plays a crucial role in the context of rise in the productivity of the host countries. In case of countries that make foreign direct investment in other countries this process has positive impact as well. In case of these countries, their companies get an opportunity to explore newer markets and thereby generate more income and profits. It also opens up the export window that allows these countries the opportunity to cash in on their superior technological resources. It has also been observed that as a result of receiving foreign direct investment from other countries, it has been possible for the recipient countries to keep their rates of interest at a lower level. It becomes easier for the business entities to borrow finance at lesser rates of interest. The biggest beneficiaries of these facilities are the small and medium-sized business enterprises. Disadvantages of FDI The disadvantages of foreign direct investment occur mostly in case of matters related to operation, distribution of the profits made on the investment and the personnel. One of the most indirect disadvantages of foreign direct investment is that the economically backward section of the host country is always inconvenienced when the stream of foreign direct investment is negatively affected. The situations in countries like Ireland, Singapore, Chile and China corroborate such an opinion. It is normally the
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responsibility of the host country to limit the extent of impact that may be made by the foreign direct investment. They should be making sure that the entities that are making the foreign direct investment in their country adhere to the environmental, governance and social regulations that have been laid down in the country. The various disadvantages of foreign direct investment are understood where the host country has some sort of national secret something that is not meant to be disclosed to the rest of the world. It has been observed that the defense of a country has faced risks as a result of the foreign direct investment in the country. At times it has been observed that certain foreign policies are adopted that are not appreciated by the workers of the recipient country. Foreign direct investment, at times, is also disadvantageous for the ones who are making the investment themselves. Foreign direct investment may entail high travel and communications expenses. The differences of language and culture that exist between the country of the investor and the host country could also pose problems in case of foreign direct investment yet another major disadvantage of foreign direct investment is that there is a chance that a company may lose out on its ownership to an overseas company. This has often caused many companies to approach foreign direct investment with a certain amount of caution. At times it has been observed that there is considerable instability in a particular geographical region. This causes a lot of inconvenience to the investor. The size of the market, as well as, the condition of the host country could be important factors in the case of the foreign direct investment. In case the host country is not well connected with their more advanced neighbors, it poses a lot of challenge for the investors. At times it has been observed that the governments of the host country are facing problems with foreign direct investment. It has less control over the functioning of the company that is functioning as the wholly owned subsidiary of an overseas company. This leads to serious issues. The investor does not have to be completely obedient to the economic policies of the country where they have invested the money. At times there have been adverse effects of foreign direct investment on the balance of payments of a country. Even in view of the various disadvantages of foreign direct investment it may be said that foreign direct investment has played an important role in shaping the economic fortunes of a number of countries around the world. Foreign direct investment incentives may take the following forms: low corporate tax and income tax rates tax holidays other types of tax concessions preferential tariffs special economic zones investment financial subsidies
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soft loan or loan guarantees free land or land subsidies relocation & expatriation subsidies job training & employment subsidies infrastructure subsidies R&D support
derogation from regulations (usually for very large projects)
Foreign Direct Investment Theory The Eclectic Theory was evolved by John Dunning The Eclectic Theory was evolved by John Dunning, emeritus professor at the Rutgers University (United States) and University of Reading (United Kingdom). The OLI Paradigm is a mix of 3 various theories of foreign direct investment, that concentrating on a various question. FDI= O + L + I O- Ownership Advantages (or FSA - Firm Specific Advantages). This firm specific advantage is usually intangible and can be transferred within the multinational enterprise at low cost (e.g., technology, brand name, benefits of economies of scale). The advantage either gives rise to higher revenues and/or lower costs that can offset the costs of operating at a distance in an abroad location. A Multinational enterprise operating a plant in a foreign country is faced with additional costs paralleled to a local competitor. The additional costs could be specified: a) b) c) a failure of knowledge about local market conditions legal, institutional, cultural and language diversities the increased costs of communicating and operating at a distance
Consequently, if a foreign firm is to be successful in another country, it must have some kind of an advantage that vanquishes the costs of operating in an abroad market. Either the firm must be able to earn higher revenues, for the same costs, or have lower costs, for the same revenues, than comparable native firms. Since merely abroad firms have to pay costs of foreignness, they must have other methods to earn either higher revenues or have lower costs in order to able to stay in business. Profit = Total revenues - Total costs - Cost of operating at a distance. The Multinational enterprise must have some separate advantages with its competitors, if it wants to be profitable abroad. Advantages
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must be particular to the firm and readily transferable between countries and within the firm. These advantages are called ownership or core competencies or firm specific advantages (FSAs). The firm has a monopoly over its firm specific advantages and can utilize them abroad, resulting in a higher marginal return or lower marginal cost than its competitors, and thus in more profit. Exist three basic types of ownership advantages (or Firm Specific Advantages) for a multinational enterprise, that it can posses. There are: a) Monopolistic advantages that receive to the Multinational enterprise in the form of privileged access to output and input markets through ownership of scarce natural resources, patent rights, and the like. Technology, knowledge broadly defined so as to contain all forms of innovation activities Economies of large size (advantages of common governance) such as economies of learning, economies of scale and scope, broader access to financial capital throughout the Multinational enterprise organization, and advantages from international diversification of assets and risks.
b) c)
L - Location Advantages (or Country Specific Advantages - CSA). The firm must use some foreign factors in connection with its native Firm Specific Advantages (FASs) in order to earn full rents on these FSAs. Therefore the locational advantages of different countries are key in determining which will become host countries for the Multinational enterprises. Clearly the relative attractiveness of various locations can change over time so that a host country can to some extent engineer its competitive advantage as a location for foreign direct investment. The country specific advantages (CSAs) can be separate into three classes: a) b) c) E - Economic advantages consist of the quantities and qualities of the factors of production, transport and telecommunications costs, scope and size of the market, and etc. P - Political Advantages include the common and specific government policies that influence inward Foreign Direct Investment flows, intra-firm trade and international production. S - Social, cultural advantages include psychic distance between the homes and host country, language a cultural diversities, general attitude towards foreigners and the overall position towards free enterprise and finally.
I - Internalization Advantages (IA). The Multinational enterprises have several choices of entry mode, ranking from the market (arms length transactions) to the hierarchy (wholly owned subsidiary). The Multinational enterprises choose internalization where the market does not exist or functions poorly so that transactions expenses of the external route are high.
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The subsistence of a particular know-how or core ability is an asset that can give rise to economic rents for the firm. These rents can be earned by licensing the Firm Specific Advantages to another firm, exporting products using this Firm Specific Advantages as an input, or adjustment subsidiaries abroad. The 1980s and 1990s have seen major changes in the business environment facing organizations. Within Europe there has been the opening up of markets following on from the development of the Single European market, and further business opportunities are likely to result from the development of a single currency. The process of internationalization has been further enhanced by the continued liberalization of trade through the GATT (General Agreements on Tariffs and Trade) and subsequently by the World Trade Organization (WTO). New technology has also played its part in providing greater access to information and therefore markets, as well as aiding competitiveness and widening consumer demand. At the same time the major developed countries in the West have experienced a process of deindustrialization with the decline in their manufacturing sectors and a concomitant rise in their service sector. Whilst many large organizations have been shedding labour the EU predicts that it will be the small firm sector which will be the major generator of future employment. It is against this background that this article sets out to consider the reasons why organizations seek to internationalize, the ways in which the internationalization process has taken place and the role of the small firm in internationalization operations. Reasons for Internationalization There is no single explanation of the factors behind organizations seeking to expand into foreign markets. Transaction costs provide one explanation; the substitution of internal organizations for market exchange permits the internalization of transaction costs and a subsequent reduction in contracting and monitoring. As Williamson (1985) notes, an advantage of the organization is that intraorganisation activities are more easily and sensitively enforced than inter-organization activities. Thus because of transaction costs - the costs of using the market organizations may seek to grow both vertically, horizontally or in a conglomerate fashion. Organizations may also seek to internationalize to achieve economies of scale and economies of scope. Both give unit cost reductions as output increases, the former through the advantages of buying in bulk, having cheaper access to finance etc., while the latter are achieved through changes in average costs as a result of alterations in the mix of production between two or more products. For unrelated products scope economies can come about through the sharing of inputs in the production process, such as management, administration or storage facilities. For related products there may be cost advantages through complementarily of production, both Ford and Toyota produce different models using common assembly and production equipment. Porter (1980) suggests that internationalization is one way by which an organization can attempt to mitigate the effects of increasingly competitive markets, particularly as markets and products mature. An example of such behaviour can be seen in the banking and building society sectors and through the behaviour of car manufacturers, airlines and coach operators.
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The maturing of markets and the different stages of a products lifecycle can also be preferred as reasons behind the internationalization of companies. Organizations require a portfolio of products, preferably at different stages of their lifecycle, to ensure both current and future earnings. In this respect companies may try to acquire elements missing from their own portfolios, especially if they lack star products or the potential to develop new products. For example, the takeover of Row tree by Nestle, which, having identified chocolate confectionary as a gap in its existing portfolio, elected to fill it by acquisition rather than entry into a highly competitive market. The desire to achieve cost savings is another driver of internationalization. For example, Fiats entry into Eastern Europe and the formation of Ford Europe has enabled both organizations to exploit lower cost areas. However, it should be noted that cost reductions do not always lead to internationalization; they may simply lead to relocation. Boundary changes may also be triggered by changes in the macroeconomic environment such as the upsurge in merger activity that followed the passing of the Single European Act. Organizations might also seek to internationalize to gain sales, operation, investment and management synergy. External factors are also important in altering the boundaries of the organization. The formation of trading blocs such as the North American Free Trade Agreement (NAFTA) or the European Union (EU) has had a profound effect on the way in which organizations view world markets and plan international investment or export sales. Worldwide economic cycles also play their part. In times of recession, markets become intensely competitive, with organizations looking to more international expansion to reduce their exposure at home. Conversely, when economies move into their boom phases, organizations have sufficient profits to grow internationally. Labour costs can also provide the stimulus for internationalization. The term new international division of labour (NIDL) has been used to explain the shift in production from core industrialized economies to less developed countries, as transnational seek cheap, controllable labour on a global scale. Further, there may be push factors which, in industrialized economies, combine to encourage organizations to look for new locations, such as declining profits and an increasingly militant or rigid labour market. Finally, technological factors play an important part in widening the markets which an organization serves. Advances in technology make previously restricted markets profitable to enter. Organizations may expand into these markets by locating there or expand their provision in the domestic market and export goods and services. As Dicken (1998) notes, technology is without doubt, one of the most important contributory factors underlying the internationalization and globalization of economic activity. He identifies advances in communications and transport as fundamental space shrinking technologies which have facilitated the development of the global organization. The export process is made more complex by the wide variety of documents that the exporter needs to complete to ensure that the order reaches its destination quickly, safely and without problems. These documents range include those required by the South African authorities (such as bills of entry, foreign exchange documents, export permits, etc.), those required by the importer (such as the proforma and commercial invoices, certificates of origin and health, and pre-shipment inspection documents), those
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required for payment (such as the South African Reserve Bank forms, the letter of credit and the bill of lading) and finally, those required for transportation (such as the bill of lading, the airway bill or the freight transit order). Documentation requirements for export shipments also vary widely according to the country of destination and the type of product being shipped. Most exporters rely on an international freight forwarder to handle the export documentation because of the multitude of documentary requirements involved in physically exporting goods and it is strongly recommended that you also make use of a freight forwarder to help you work your way through the maze of documentation. Click here for a list of freight forwarders that you can approach to help you.
2.2 The Benefits of Documentation

Documentation is a key means of conveying information from one person or company to another, and also serves as permanent proof of tasks and actions undertaken throughout the export process. Documentation is not only required for your own business purposes and that of your business partner, but also to satisfy the customs authorities in both countries and to facilitate the transportation of and payment for goods sold. One value of documentation is that copies can be made and shared with the parties involved in the export process (although you should always ensure that you make identical copies from an agreedupon master - it is no use making changes without the other partys agreement and then presenting these as the latest copies). If the documentation is complete, accurate, agreed upon by the parties involved and signed by each of these of these parties (or their representatives), the document will represent a legally binding document. Function of Export Documentation Export documentation may serve any or all of the following functions: An attestation of facts, such as a certificate of origin Evidence of the terms and conditions of a contract if carriage, such as in the case of an airway bill Evidence of ownership or title to goods, such as in the case of a bill of lading A promissory note; that is, a promise to pay A demand for payment, as with a bill of exchange A declaration of liability, such as with a customs bill of entry A receipt for goods received.
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There are five broad categories of documentation you will encounter when exporting. These are: Documents involving the importer The proforma invoice The export contract The commercial invoice The packing list Letter of credit Certificate of origin Certificates of health Fumigation certificate Pre-shipment inspection certificate
Proforma Invoice A proforma invoice is little more than a preadvice of what will stand in the commercial invoice once negotiations have been completed. Indeed, the proforma invoice and the commercial invoice often look exactly the same, except that it should state clearly proforma invoice on this document, whereas the commercial invoice will state invoice or commercial invoice. The proforma invoice serves as a negotiating instrument. The initial proforma invoice often sets the stage for the first round of negotiations if the exporter and importer have not yet had any real discussions. What is the difference between a proforma invoice and a quotation? In reality, there is very little difference in function between the two and the proforma invoice is really a quotation in invoice form; in other words. The difference really comes about in terms of the structure and layout of the proforma invoice/quotation. A quotation appears more like a business letter describing a written offer, while a proforma invoice appears exactly the same as a invoice (except with the words proforma invoice written on the document). The proforma invoice essentially serves as a quotation that sets the road to further negotiations. Some exporters choose to prepare an official quotation, while others prefer to use the proforma invoice as their quotation. In fact, the quotation can contain the same information as a proforma invoice. The role of the proforma invoice in the negotiation process Assuming that an importer e-mails you - an exporter - asking you to submit a proforma invoice (or a quotation) for the supply of 100 pumps according to a set standard. You would then prepare and
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submit a proforma invoice to the potential importer outlining a description of the product, what the price is, what the delivery terms will be, what the payment terms will be, as well as any other information that may be pertinent to the sale. The importer will most likely reply to your proforma invoice requesting/ negotiating different requirements such as a lower price, longer terms of payment, different methods of payment, a different delivery schedule and may even request changes to the product specifications. Based on these requests from the importer, you may choose to comply or to refer back to the importer (probably via telephone, fax or e-mail) to discuss or negotiate compromises to these requirements. When you and the importer finally come to an agreement, a second (sometimes even third or fourth) proforma invoice will be exchanged between the two parties. This final proforma invoice - accepted by the importer - sets the stage for the further processing of the order. You should be aware that the importer may use the proforma invoice to request foreign exchange within his/her country if his/her currency is not freely convertible. The proforma-invoice can also help the importer apply for a letter of credit at his/her bank. In other instances where the exporter and importer have met before and have already discussed and thrashed out an agreement perhaps in a face-to-face meeting, only one final proforma invoice is necessary to confirm that the two parties are indeed in agreement. Every proforma invoice should be as precise and as explicit as possible to ensure that both parties understand each other. If the importer is satisfied with this final proforma invoice, he/she will request their bank to issue an L/C on the strength of information stipulated in the proforma invoice. For this reason, it is essential that the proforma invoice be extremely accurate, clear and concise. Any errors or misunderstandings will be transferred to the L/C and will cause problems, frustrations and delays down the line. What is more, the proforma invoice is also important to the importer for the purpose of obtaining an import permit and foreign exchange allocation within his country. At the same time, the exporter may use the proforma invoice and acceptance of the order from the importer to obtain funding to pay for the manufacturer of the goods concerned.

1. 2. 3. 4. What do you mean by Foreign Direct Investment and explain its features. What are determinants of Foreign Direct Investment? What are the disadvantages of Foreign Direct Investment? What is Internationalization and explain the concepts.
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Module III FINANCIAL ENVIRONMENT OF INTERNATIONAL BUSINESS

International Finance International Financial Environment Management of Foreign Exchange Risk International Financial Market International Financial Institutions Government institutions Foreign Financial Market & Exchange Determination Exchange Rate
3.1 International Finance

International finance, an offshoot of economics, encompasses a detailed understanding of exchange rates and foreign investment and their impact on international trade. Analysis of international projects, overseas investments, cross border capital flows, trade deficits, currency swaps and global financial markets are some of its key areas of study. Individual investors usually focus on that part of international finance that deals with global futures and options and the forex market.
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There are various global bodies regulating different aspects of international finance. These include: IFC: International Finance Corporation is a prominent entity supporting sustainable investments in the private sector of developing countries to stimulate their growth. It is the biggest source of multilateral loans and equity financing for projects undertaken by the private sector in developing countries. IFC plays a key role in providing technical assistance to businesses and governments of developing countries. IMF: International Monetary Fund monitors the balance of payments of its member countries. It is regarded as the lender of last resort for countries facing a financial crisis, such as deficits and currency crisis. The relief amount is relative to the size of the countrys contribution in the global trading system. World Bank: It funds the development of projects, mainly in developing countries, that are not financed by the private sector. WTO: World Trade Organization resolves multilateral and bilateral trade disputes in addition to the negotiation of different trade agreements among its various member nations.
Some of the benefits of international finance are: Access to capital markets across the world enables a country to borrow during tough times and lend during good times. It promotes domestic investment and growth through capital import. Worldwide cash flows can exert a corrective force against bad government policies. It prevents excessive domestic regulation through global financial institutions. International finance leads to healthy competition and, hence, a more effective banking system. It provides information on the vital areas of investments and leads to effective capital allocation. International finance promotes the integration of economies, facilitating the easy flow of capital. The free transfer of funds would eventually result in more equality among countries that are a part of the global financial system.
3.2 International Financial Environment

Investment Decisions A very important decision which organizations involved in international business must, take is what projects are to be financed? and in which nations these are to be financed. These questions which relate
Module III - Financial Environment of International Business
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to the investment decisions are of prime importance from the perspective of parent organization. If answered wrongly then they could create perennial problems for the organization or could lead to heavy losses or could result in complete failure. On the other hand, if these are answered correctly, then they could lead to increase in profits for the parent organization or increase in market share of the organization or could provide a source of competitive edge to the organization. In order to decide about where to invest and where not to invest, organization looks at a large numbers of factors like the socio-cultural, economic, political, legal, natural and demographic environment of the host nation. After analyzing the environmental factors the organization develops an idea about the benefits, costs and risks associated with the investment. Capital Budgeting The top management of the organization can take a decision about the investment only when it has a definite idea about the benefits, costs and risks associated with it. Capital budgeting is a technique which quantifies the benefits, costs and risks involved with an investment or a project. Thus capital budgeting allows the top management to easily compare different projects in different nations and make informed choices about where to make the investment. In carrying out capital budgeting the organization involved in international business uses the same theoretical framework as used by an organization involved in domestic business, i.e., the organization makes use of concepts like cash inflows, outflows, discount rate, etc. in order to find out the Net Present Value (NPV) of the project. If the NPV comes out to be greater than zero, then the organization can go for the project. In spite of the fact that certain similarities exist between the capital budgeting technique followed by an organization involved in the international business and the technique followed by an organization involved in the domestic business, there are certain dissimilarities also. Some of the aspects of capital budgeting which are specific to foreign project assessment are: The cash flows occurring from the projects must be analyzed from the perspective of the parent organization. For example, there is a possibility that two foreign subsidiaries of the organization may want to set up, each, a new plant for the manufacturing of the same product and for supplying in the same market, on the basis of positive NPV criteria. If this is allowed then it could create a situation where subsidiaries of the same organization will compete with each other, and as a result, chances are that the profit from the projects may not materialize as per the expectations. So, in such a situation; the parent organization must reject the proposal of one of the subsidiaries that will result in a lower positive NPV to it and accept the proposal of the subsidiary which will result in a higher positive NPV to it. The cash flows occurring to the project are not necessarily the cash flows that will occur to the parent organization. It is often seen that because of the policies, rules and regulations of the host nation it is not always possible to remit all the cash flows, which are generated from the
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project, to the parent organization in the home nation. This situation could arise because of the foreign currency controls exercised by the host nation, which sometimes block the repatriation of cash to the home nation or which heavily taxes the cash flows that are to be repatriated or which require that a certain percentage of cash flows generated from the project should be reinvested in the host nation. So, from the perspective of the parent organization the cash flows that are not remitted to it are of less value as these cannot be used for the payment of dividends to the stockholders or for repayment of worldwide debt or for reinvestment in other parts of the globe. But from the angle of the project these are cash flows which should be used for calculating NPV of it. The political risk, which refers to the change in the political environment of the host nation that adversely affects organizations goals, can substantially reduce the value or expected cash flows of the project. The political risk tends to be more in case of the nations where the government is autocratic, which are passing through a period of social unrest and which are less developed. In case of these nations, the chances are that with the change of government the policies will change and these changes will negativity affect the foreign organizations operations in the nation. The result of change in policies could be the expropriation of the foreign organizations assets as happened after the Iranian revolution of 1979 or it could be the increase in taxes or imposition of additional taxes on the cash flows that are to be repatriated back. The economic risks associated with the foreign investments are more than the domestic investments, and mainly relate to increase in the inflation rate in the host nation, depreciation in the value of the local currency or erratic fluctuations in the exchange rate of the host nation currency. All these developments or developments in any of these could drastically affect the cash flows that occur to parent organization-It is seen that many organizations pay considerable attention to political and economic risk analysis while going for investments in foreign projects. Normally, organizations follow two approaches for tackling these risks. One is that they increase the discount rate is the NPV formula for the nations where the perceived risk is high. The second approach which the organizations follow is that they reduce the future cash flows from the project. The logic is that normally foreign investment is not made in a nation where the apparent immediate political and economic risk is high as multinational organizations shy away from making investments in these. But as time elapses, the situation changes and the probability of these risks become high, so in order to incorporate these future risks associated with the foreign investments the organizations reduce the future cash flows. For example, Union Carbide, a U.S. Multinational enterprise, has incorporated political risk in its capital budgeting process.
Financing Decisions Since the organization is able to decide about the foreign project which it will be taking for investment, the next question which arises for it is how to finance the investment? That is the organization has to decide about the source of financing and the structure of financing. In source of financing, the organization
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has to decide that whether it will be using internal sources or external sources for generating the required funds. In structure of financing the organization has to decide about the mix of debt and equity, which it will be using for financing the project. Source of Financing As far as the sources of financing are concerned, the organization has to decide that whether it will be using internal sources for financing the project or external sources or a combination of the two. If the organization decides to make use of the internal sources for financing a new project in the host nation, then it has the following options: If a subsidiary in the host nation is responsible for the new project then it could make use of the funds which it gets by selling the product or by providing the service in the host nation. The subsidiary can get the funds from the parent organization. The subsidiary can also get the required funds from some other subsidiary in the same nation or from some other nation. The organizations mainly go for utilizing the internal sources of finance for one or some of the following reasons: To minimize the cost of fundingthe cost of generating the required funds internally, if possible, is always less than the cost of getting the same from external sources. To make use of organizations blocked fundssometimes, the organization finds that its funds are blocked in some foreign nation X because of the policies of the concerned nation which does not allow repatriation of the funds. So, in this case, the organization can start a new project in X using the excess funds which are available in its accounts in the nation or if it wants to fund the project in nation Y then it can do so by finding a bank which has its branches in both the nations X and Y. Then it can enter into an agreement with the bank, if possible, that the bank should provide loan in nation Y in nation Ys currency and should accept the payment in nation X, in the currency of nation X. Out of convenience in certain cases the organization finds that the external market has become saturated for it so it cannot raise the required funds from it, therefore, it goes for internal sourcing of funds for financing of the project.
Financial Structure The financial structure adopted by an organization for financing an investment varies from nation to nation and organization to organization. That is there is no standard format available regarding the amount of debt and equity which should be used for financing the projects in all situations, across nations, worldwide. According to a study of organizations, in 23 nations, it was found that the average
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debt to equity rate was 0.34 in Singapore, 0.55 in the U-S-A. 0.55 in U.K., 0.62 in Germany and 0.76 in Italy . In general it has been seen that the Japanese organizations rely more on debt financing than their U.S. counterparts. The reason for the same could be the government policies or the cultural reasons. The organization can raise the capital in the debt form either by taking loans from the banks in the home nation or host nation; or by getting the finances from the Eurocurrency market; or by raising it through bonds. The international bond market can be divided into foreign bonds and Eurobonds. The foreign bonds are sold outside the borrowers nation, but are denominated in the currency of the nation in which they are issued. For example, an Indian organization issuing bonds in U.S. dollars in the U.S.A. The Eurobonds are underwritten by a syndicate of banks and are issued in the nations other than the one in whose currency they are denominated. For example, a Japanese organization issuing bonds in US dollars and selling it in nations other than U.S.A. The main drawback of this approach is that it increases the financial risk. For example, the major cause of the Asian financial crisis of 1997 was the excessive reliance on debt, especially bank debt. Another important source of external financing available to organization involved in international business is the global equity market. In case of equity market the financer takes an ownership position by way of the stock of shares of the organization, which it holds. The organization involved in international business can raise the capital from equity market by following the approaches mentioned as under: 1. 2. The organization can get the capital through private placement with a venture capitalist. The organization can also raise the equity capital by listing their stocks on the domestic and foreign exchanges. For example, after the merger of Daimler and Chrysler, the new organization issued global shares in 21 different markets in eight nations. Another option for raising equity capital is by way of ADRs, GDRs and IDRs.
3.
Management of Global Cash Flows The efficient management of global cash flows significantly affects the profit line of organizations involved in international business. In trying to achieve this efficiency objective, the organizations, mainly, concentrate on reducing cash balances, reducing transaction costs and reducing taxes globally. Reducing Cash Balances One of the factors which can affect the objective of efficient management of global cash flows is the amount of cash balances that an organization holds for meeting the normal payment requirements and also to meet the unexpected demand for cash, during a given period of time.
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Normally, the organization invests the excess funds, which are over and above the required cash balances, in long-term financial instruments, such as bonds, certificates of deposit, etc. The period of these instruments is generally six months or more and they yield a higher rate of return on the investments. The cash balances which the organization keep in order to meet the payment requirements cannot be invested in long-term financial instruments as these could be demanded any time during the period for payments. So, these are normally invested by the organization in money market accounts from which they could be withdrawn freely at any moment of time. The period of these investments is, mostly, less than or equal to three months and they yield a relatively low rate of interest. The problem which the organization faces is that if it invests more in long-term financial instruments then chances are that it may not be able to meet the cash requirements of the period because of limited liquidity. .On the other hand, if it invests less in long-term financial instruments then the organization will be having ample amount of liquidity but less return on investments. So, the persistent problem of the organization involved in international business and having subsidiaries in many nations is that how to minimize the cash balances and at the same time be able to meet all its cash requirements. Centralized depository is one approach which the organizations follow in .order to reduce the cash balances and maximize the returns on investments. In this approach, the multinational enterprise instead of allowing the individual subsidiaries to maintain their cash balances hold the cash balances at a centralized depository. The most important advantage of this approach is that it reduces the required size of cash balance. In other words, it means that if individual subsidiaries maintain their cash balances then the sum of these cash balances will always be more than the cash balance which-will be required at the centralized depository. So, if the organization follows the centralized depository approach then it can always invest more in high yielding long-term financial instruments then is otherwise possible. The second advantage of this approach is that it is able to pool a large amount centrally. This large amount can be invested, on the advice of financial experts at the best, money market accounts. The result is a higher return on the short-term investments where the rate of return depends on the size of amount. Reducing Transaction Costs According to the United Nations, nearly, 40 per cent of the international trade takes place between different subsidiaries of the multinational enterprises. It occurs on account of the fact that the MNEs want to carry out the different value creating activities at the optimal locations globally. This brings into focus the issue of intra-organization transaction costs, i.e., the costs of changing cash from one currency into another and transferring the same to another location. The transaction cost consists of two elements. The first element is the commission which is paid by the organization to the foreign exchange dealers for the conversion of the currency and the second element is the transfer fee which is paid to the bank for moving the cash from one location to another. The transaction cost is high for an organization if it has
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many subsidiaries, and all of them have to make and receive payments from each other. This high transaction cost could be reduced by following the process of multilateral netting. In multilateral netting the organization sets up a central clearing account with the authority to make and receive the necessary payments to and from the different subsidiaries in order to settle the intra-organization subsidiary obligations, efficiently and at minimum transaction costs. Reducing Taxes Globally It is seen that the corporate tax rate is different in different nations. Moreover, it also varies from industry to industry. So, organizations involved in international business try to minimize the total tax paid by them by making use of different approaches for transferring the funds globally. Some of the important approaches followed by MNEs for transferring the funds include dividend remittances; royalty payments and fees; transfer pricing; fronting loans; and use of tax havens. Dividend Remittances One of the most common approaches followed by the organizations for transferring the funds from the subsidiaries to the parent organization is by way of payment of dividends. This approach becomes less attractive if the host nation government levies a high tax on dividend payments, or there is an upper limit on the total amount that could be remitted by way of dividends in a year. Additionally, payment by way of dividends could become unattractive if the income earned by the subsidiary is taxed by both the home and host nation governments. The problem of double taxation, i.e., taxes imposed by the home and the host nation, could get mitigated by way of tax treaties, tax credits and the deferral principle. In general, a tax treaty is a contract between the two nations that specifies which income earned by the subsidiary will be taxed by the host nation and which will be taxed by the home nation. A tax credit lets the organization to reduce the tax which is paid to the home nation by the amount which has been already paid as tax to the host nation. Finally, the deferral principle says that the parent organization cannot be taxed on the foreign subsidiary income until it actually receives the same. Royalty Payments and Fees Sometimes the organization finds that the tax imposed by the host nation on the income earned by the subsidiary is quite high as compared to the tax imposed by the home nation. So, in order to reduce the high tax burden of the host nation the organization tries to deflate the subsidiary income by increasing its expenses, substantially, on the payment of royalties and other fees to the parent organization. The royalty payment is the money paid to the owners of technology, patents or brand names, for the use of the same by the organization. When the organization finds that there is a high tax, in the host nation, on the income that is transferred to the parent organization by way of dividends then it tries to transfer substantial amount of funds to the parent organization in the form of royalty payments for the use of technology, trademark, etc. of it.
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The organization also tries to transfer funds from the subsidiary to the parent organization in the form of fee which is paid by the former to the latter for the managerial or technical expertise which the former receives from the latter. Generally, the payments made in the form of royalties and fees are treated as expenses made by the subsidiary, and hence they are tax deductible in the host nation. Transfer Pricing A transfer price is the internal price at which the goods and services are transferred between different units of the same organization. It refers to the price at which goods/services are transferred from one subsidiary of the organization to another or from subsidiary to parent organization or vice versa. Normally, it is assumed that the transfer price will be the market based price or it will be slightly less than the market prize on account of the fact that certain discount will be given to intra-org animation dealings. But the reality is that many organizations manipulate transfer prices in order to avoid or reduce tax liabilities. For example, organization tries to move funds out of the nation where the tax rate is high by charging a high transfer prize for the goods/services which are supplied to the subsidiary based in it; and on the other hand, paying a low transfer price to the goods/services supplied by the subsidiary based in it. This way the organization is able to deflate the income which is generated in a high tax nation. Suppose an organization is having its subsidiaries in two nations X and Y (refer to Table 1). In case of nation X, the tax rate is 20 per cent, whereas in case of nation Y the tax rate is 40 per cent. Consider the situation in which the infra-organization transactions. Between the two subsidiaries, takes place at the market based prices. The subsidiary in national X sells the goods/services to subsidiary in nation Y at Rs. 40 lakhs, and hence earns profit of Rs. 5 lakhs, whereas the subsidiary in nation Y sells the goods/ services at Rs. 45 lakhs, and also makes a profit of Rs. 5 lakhs. But owning to the different tax rates in X and Y, the net profit for the subsidiaries, after paying the taxes, comes out to be Rs. 4 lakhs and Rs. 3 lakhs. respectively- Thus, for the organization as a whole, the total net profit is Rs. 7 lakhs and total taxes Rs. 3 lakhs.
Table 1: Transfer Pricing
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Now consider another situation in which the organization manipulates transfer prices m order to reduce the total tax and increase the total net profit. In this case, the subsidiary in X sells the goods/services to subsidiary in Y at a transfer price of Rs. 45 lakhs, whereas He subsidiary in Y also sells it at a price of Rs. 45 lakhs. Thus, the profit for subsidiary in X runs out to be Rs. 10 lakhs, whereas the same is nil in the case of subsidiary in Y. Thus the organization is able to reallocate its income from a nation where tax rate is high to a nation where the same is low. The result is that the net profit after paying taxes in nations X and Y stand at Rs. 8 lakhs and nil respectively. Hence, for the organization as a whole the total tax under manipulated transfer prices is Rs. 2 lakhs and total profit is Rs. 8 lakhs. Therefore, is manipulating the transfer prices, the organization is able to reduce its tax by Rs. 1 lakh. Nowadays manipulating transfer prices arbitrarily is not easy as nations around the world have become vigilant towards it and feels cheated if the organizations try to use it for avoiding tax liabilities or circumventing government restrictions on capital flows. Many nations HE trying to rewrite their tax laws in order to check arbitrary manipulation of transfer prices, for example, in the case of U.S.A., the Internal Revenue Service (IRS) can reallocate the gross income, deductions, credits, etc. between different units of the organization in order to present tax evasion. In doing so the IRS makes use of the arms length price in order to decide about transfer price. The arms length price is the market price that would be demanded .aid paid by unrelated organizations. The burden of proof lies on the organization to show that 33$ has done the re-allocation unreasonably. Fronting Loans A loan which is given by the parent organization to the subsidiary in the host nation, indirectly, through a commercial bank is known as a fronting loan. In fronting loan the parent organization, suppose based in the U.S.A., instead of directly giving Joan to its subsidiary in China, deposits loan to the subsidiary in China. The deal is risk free and profitable for the bank as it has 100 per cent collateral in the form of parents deposit and it pays a slightly low interest rate on the deposit than it charges for the amount which it has loaned. In certain cases, the organizations find that there is a high tax on the remittance of dividends to the parent organization and arbitrary manipulation of transfer prices is also not possible. So, organizations try to transfer funds from the host nation to the parent organization by way of payment of interest to the international bank on the loan which it has taken from it. The bank, in turn, gives back the interest, slightly less, to the parent organization on the deposit made by the same. Generally, the host nation government does not restrict or check the interest which is paid to the bank as it doesnt want to spoil its mutually advantageous relations with the same. Tax Havens A tax haven is a nation or jurisdiction with no or very low rate of income tax. Some examples of the same are the Bahamas, Switzerland, Monaco and Andorra. The organizations involved in international business try to reduce or avoid their tax liabilities by setting up their subsidiaries in these locations. Then
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they arbitrarily manipulate transfer prices in order to reallocate income from high tax nation to the subsidiary situated in tax haven. Sometimes, organizations headquartered in the nations where the deferral principle is accepted, i.e., the parent organization situated in the nation is not taxed for the income which is generated by its subsidiaries in foreign locations until it receives the same; try to establish subsidiaries in tax havens and channel all funds to the parent organization through it. The objective is that if funds are required for further foreign operations then they should be held at the tax haven subsidiary and should be invested from there as and when required. By doing this the organization is able to reduce the tax burden as the funds that are held at tax haven are not taxed. On the other hand, if these funds would have reached the parent organization directly, bypassing the tax haven, then these funds would have been taxed by the home nation before investing the same for further foreign operations.
3.3 Management of Foreign Exchange Risk

The management of foreign exchange risk is an important component of international financial management strategy of any organization. It involves finding and defining the type of foreign exchange exposure that the organization faces and the strategy for managing the same. Transaction Exposure It is the extent to which an organizations paying bills and collecting receivables, from individual transactions, get affected due to fluctuations in exchange rates. For example, an Indian organization enters into a contract to import 500 computers from U.S.A. at the rate of $700 per computer. The dollar/rupee spot exchange rate is $1= Rs.50. The cost of one computer in rupees is Rs.35,000. The organization feels that it can sell the computers the day they arrive at Rs. 37,000 per piece. Thus, it expects to make Rs.2000 as profit. Suppose, the dollar appreciates and the new exchange rate becomes $1 = Rs.55- Therefore, when the computers arrive the organization pays Rs. 38,500 (55 x 700) per computer to the U.S. exporter. Thus, the fluctuation in the exchange rate turns the deal into an unprofitable one (Rs.2000 per computer profit) into an unprofitable one (Rs, 1500 per Computer Loss) In this case, the transaction exposure per computer for the Indian organization b Rs-3500 (Rs.38,500 - Rs. 35.000), which is the amount .that the organization has lost one due to change in the exchange rates. Transition Exposure is the extent to which the reported position of a subsidiary gets affected due to change in the exchange rate. Suppose, the Indian rupee depreciates from Rs. 50 per dollar to Rs. 55 per dollar. Now this change in exchange rate will substantially reduce the dollar value of the Indian subsidiary of U.S. multinational enterprise. This change is not going to affect the local purchasing power of rupee, in the short, or deposit in rupee, but this will definitely affect the dealings which will take place in dollars or other foreign currencies.
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Economic Exposure
The economic exposure is the extent to which the long-term prices, sales and costs, of m organization get affected due to change in the exchange rates. For example, in the early 1980s, when the U.S. dollar became strong against the Japanese yen then it had a profitable impact against the Japanese exporters as their exports became cheap in U.S. market. On the other hand, when the U.S. dollar started declining against the Japanese yen since the mid-1980s it negatively affected the Japanese exports as they became costlier in U.S. markets. The organizations involved in the international business can manage transaction aid translation exposures by resorting to number of tactics such as forward exchange contracts; currency swaps; lead and lag strategies. These strategies basically protect short-term cash flows from fluctuations in exchange rates. A lead strategy requires collecting foreign exchange receivables early if the foreign currency is expected to depreciate, and making the payments early if it is expected to appreciate. On the other hand, a lag strategy requires delaying in collecting the foreign currency receivables if the foreign currency is expected to appreciate, and delaying in making the payments if n is expected to depreciate. As far as management of economic exposure is concerned, the same could be achieved by reallocating the organizations value creating activities in different nations. For example, after the mid-1980s when the Japanese yen started strengthening against the U.S. dollar, the Japanese exports became uncompetitive in the U.S. markets as the change in exchange are converted Japan from a low-cost manufacturing location to a high-cost manufacturing location. Therefore, Japanese auto companies started shifting their manufacturing to U.S. and other overseas locations in order to control the rise in their prices in foreign markets.
3.4 International Financial Market

Euro Dollar Market Eurocurrency market is an international capital market in which the deposits and leadings take place outside the currency of issue and the transactions are not under the general regulations of the monetary authorities of the country where they are located. Origin of Eurocurrency Markets One of the important facets of the international financial system is the Eurocurrency system. By Eurocurrency we mean the currency deposited in a bank outside the country of its origin. Example yen deposited outside Japan is Euroyen; dollar deposited outside United States is Eurodollar. A US dollar deposit in Singapore as well as a US dollar deposit in London is known as Eurodollar. Thus Eurocurrency is not Euro and is not necessarily European currency.
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The origin of Eurocurrency market can be traced back to late 1950s when the Eastern block countries were afraid of depositing dollars in the United States in fear of U.S. confiscation. Hence they deposited their money in Europe and the banks which accepted these currencies as deposits became Eurobanks. These deposits are usually borrowed or loaned by major international banks, international corporations and governments, when they need to acquire or invest additional funds. The market in which borrowing and lending takes place is called Eurocurrency market. These markets operate under a regulatory regime different from regulations applied to deposits used to execute domestic transactions. It is a parallel market in competition with traditional domestic market. Initially only dollar was used in this fashion and the market was therefore called Eurodollar market. Subsequently, other leading currencies like the British pound sterling, German mark, Japanese yen, and the French & Swiss franc began to be used this way and so the market is now appropriately called the Eurocurrency market. Growth of Eurocurrency Markets The Euro currency deposits have grown from 10 million dollars in the early 1960s to over 1 trillion dollars in 1990 and further to 9.5 trillion dollars during 1999. In the ten-year period ending 1987 the total net deposits have increased from USD 478 billion to USD 2,377 billion. Dollar-denominated deposits accounts for the largest share of the market which comes to nearly 67% of the total Eurocurrencies deposits. In dollar terms, of roughly USD 1,569 billion, this compares with a total figure of USD 2,377 billion held domestically in the U.S. by commercial banks. The reasons for the phenomenal growth of the Eurocurrency markets can be attributed to the following: Restrictive Domestic Regulatory Regime Ceiling on interest rates on deposits - Until it was abolished in 1986, the Federal Reserve System Regulation Q imposed ceilings on the interest rates that U.S. member banks could pay on deposits, to levels that were often below the rates paid by European banks. As a result short-term dollar deposits were attracted to European banks and became Eurodollars. Imposition of taxes - The Interest Equalization Tax imposed taxes on U.S. purchases of foreign securities. Also the Foreign Credit Restraint Program limits the volume of bank lending to foreigners. These regulations only further encouraged borrowers to invest the Eurocurrency markets. Capital controls - The European governments also experimented with capital controls in the 1970s. Both Germany and Switzerland imposed regulations to try to limit the non-resident demand for their currencies. These regulations helped to promote the non-dollar segments of the Eurocurrency markets. The demand for Eurodollars further multiplied when the Bank of England restricted the external use of sterling in 1957.
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Encouraging Nature of Regulation of the Eurocurrency Markets Yet another reason for the growth of the Eurocurrency markets is that the regulations of the Eurocurrency markets are such that there are; No reserve requirements No interest rates regulations No deposit insurance requirements No credit allocation regulations Less stringent disclosure requirements No withholding of taxes. 1. The nature of regulations is such that (a) International corporations could overcome domestic credit restrictions by borrowing in the Eurocurrency markets; (b) International corporations often find it convenient to hold balances abroad for short periods in the currency in which they need to make payments. Communist nations prefer to keep their dollars outside U.S. for fear that they might be frozen in political crises. Indeed this is how the Eurocurrency market originated. The rapid growth of this market stems in part from the demand for U.S. dollars as an international currency, in part from the tremendous flows of petrodollars into international banks from the oil exporting countries during the mid-1970s and early 1980s. Eurodollar deposits are not subject to Federal Reserve requirements. Hence deposit rate is typically higher and the borrowing rate is lower compared to U.S. domestic rates.
2.
Features of Eurocurrency Markets The salient features of Eurocurrency markets are: 1. 2. 3. 4. 5. The Eurocurrency markets are composed of Euro banks which accept/ maintain deposits of foreign currency and the dominant currency USD. The Eurocurrency markets are essentially wholesale markets operating at inter-bank levels. They are highly competitive as there are many Eurodollars markets operating world wide. Euro banks have no central monetary authority and hence there are no regulatory restrictions imposed by them. Eurocurrency markets operate through Euro banks, which are financial intermediaries, bringing together lenders and borrowers.
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Eurocurrency lending operation is standardized and is of high volume. Euro banks dealing with Eurocurrencies have lower regulatory costs. They are not subject to interest rate ceilings. Operations of Eurocurrency Markets Since Eurocurrencies are in the form of time deposits rather than demand deposits, they are money substitutes or near money rather than money itself. Thus Euro banks are not primarily commercial banks which are involved in credit creation. They rather operate like domestic savings and loan associations than like commercial banks. Thus they contribute to international liquidity. Euro banks are willing to accept deposits denominated in foreign currencies and are able to pay higher interest rates on these deposits than U.S. banks because they can lend these deposits at still higher rates. In general the spread between lending and borrowing rates on Eurocurrency deposits is smaller than the U.S. banks. US Lending/Deposit Rate ED Lending/Deposit Rate US Lending Rate ED Lending Rate ED Deposit Rate US Deposit Rate Eurocurrency deposit rate is higher and lending rate lower because Euro banks have lower regulatory costs, they are not subject to interest rate ceilings. A large percentage of deposits can be lent out. Most borrowers are well known and safer. Eurocurrency lending is standardized and is of high volume. Euro banks are banks that accept fixed time Eurocurrency deposits and make loans in Eurocurrency. Euro loan market is extremely competitive and lenders operate on razor thin margins. Euro loans are often quoted on the basis of London Inter Bank Offer Rate (LIBOR), the rate that London banks charge each other for short-term Eurocurrency loans. The Eurocurrency loans have floating interest rates with reference to the LIBOR. The interest rates on Eurocurrency loans are often the LIBOR plus fixed margin with LIBOR rate being reset periodically and margin determined by creditworthiness of borrowers. The volume of Eurocurrency loans is large and requires several Euro banks to form a syndicate. Borrowers are expected to pay syndication fee. Significance of Eurocurrency Markets 1. In the past the U.S. and the oil exporting countries have been the main lenders while developing countries have been the net borrowers. The intermediation function that Eurocurrency markets performed in recycling hundreds of billions of petrodollars for oil exporting countries to oil importing countries in the 1970s resulted in huge international debt problem in developing countries.
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2.
The existence of Eurocurrency markets reduces the effect of domestic stabilization efforts of national governments. For example, large firms unable to borrow domestically because of credit restrictions, often borrow in the Eurocurrency markets, thus frustrating the government effort to restrict credit to fight domestic inflationary pressures. The problem is more serious in countries following fixed exchange rate system. Large and frequent flow of Eurocurrencies from one monetary centre to another causes greater instability in foreign exchange rates and domestic interest rate. Eurocurrency markets are largely uncontrolled. As a result worldwide recession could render some of the Euro banks insolvent. But for the regulation of the Eurocurrency markets to be effective there should be greater international cooperation among major countries. On the positive side the Eurocurrency markets have certainly increased competition and efficiency of domestic banking. The intermediation function the Eurocurrency markets have performed transferring deposits of oil exporting nations to oil importing nations prevented a liquidity crisis in the 1970s. This other international financial institutions were unable and unwilling to undertake. The presence of Eurocurrency markets has promoted competition in U.S. banking. Since 1981 international banking facilities have been permitted in the U.S. That is, U.S. banks are now allowed to accept deposits from abroad and reinvest them overseas and thus compete in Eurodollar market. Several States have also passed legislations exempting profits from international banking transactions from State and local taxes. Almost 200 U.S. banks have entered this market.
3. 4.
5. 6.
7.
An early factor in the growth of international investment, and the world economy in general, was the development of the Eurocurrency market. A Eurocurrency is a dollar or other freely traded currency deposited in a bank outside the country of origin. The Eurocurrency market encompasses those banks that seek deposits and make loans of foreign currency. The phenomenal growth of Eurocurrency markets is because of the inherent strength of the Eurocurrency system, the strength emerging from. The fierce competition for deposits and loans in the Eurocurrency markets. The lower operating cost in Eurocurrency market due to the absence of legal reserve requirements and other restrictions on Eurocurrency deposits. Economies of scale in dealing with very large deposits and loans. Risk diversification. Arbitrage is so extensive in the Eurocurrency market. That interest rate parity is generally maintained.
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3.5 International Financial Institutions

The most prominent international institutions are the IMF, the World Bank and the WTO: The International Monetary Fund (http://www.imf.org/) keeps account of international balance of payments accounts of member states. The IMF acts as a lender of last resort for members in financial distress, e.g., currency crisis, problems meeting balance of payment when in deficit and debt default. Membership is based on quotas, or the amount of money a country provides to the fund relative to the size of its role in the international trading system. The World Bank (http://www.worldbank.org/) aims to provide funding, take up credit risk or offer favourable terms to development projects mostly in developing countries that couldnt be obtained by the private sector. The other multilateral development banks and other international financial institutions also play specific regional or functional roles. The World Trade Organization (http://www.wto.org/) settles trade disputes and negotiates international trade agreements in its rounds of talks (currently the Doha Round).
International Monetary Fund At the close of the Second World War there was a desire to reform the international monetary system to one based on mutual co-operation and freely convertible currencies which resulted in the Bretton Woods conference at New Hampshire in 1944, where countries agreed to tie the values of all currencies together. The Bretton Woods agreement required that each country fix the value of its currency in terms of gold. The US dollar was the key currency in the system, and USD 1 was defined as being equal in value to 1/35 ounce of gold. Since every currency had a defined gold value, all currencies were linked in a system of fixed exchange rates. Nations belonging to the system were committed to maintaining the parity value of the currency within per cent of parity. When a country experienced difficulty in maintaining its parity value due to balance of payments disequilibrium, it could turn to a new institution created at the Bretton Woods Conference, the International Monetary Fund (IMF). The International Monetary Fund (IMF) was set up under an agreement arrived at the United Nations Monetary and Financial Conference held at Bretton Woods, New Hampshire between July 1-22 1944. The agreement came into force on December 27, 1945 when it was signed by 44 countries. The inaugural meeting of the IMF was held in March 1946 at Savannah, Georgia. The IMF has its headquarters in Washington. India was an original member of the IMF. The IMF commenced its operation in Washington on March 1, 1947 and at present has 184 members. Objectives of IMF According to the Agreement, the objectives of the IMF are as given below:
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1. 2.
To promote international monetary co-operation through a permanent institution that provides the machinery for consultation and collaboration in international monetary problems. To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy. To promote exchange stability, to maintain orderly exchange arrangements among members and to avoid competitive exchange depreciation. To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade. To give confidence to members by making the Funds resources temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures which are destructive for national or international prosperity. In accordance with the above, to shorten duration and lessen the degree of disequilibrium in the international balance of payments of the member-countries. To achieve balanced economic growth especially of the backward countries by securing a rise in the level of employment. To reduce disequilibrium in balance of payments by providing assistance to its members either by selling or lending foreign currencies to them. To promote investment of capital in backward and under-developed countries through the export of capital from the richer nations to the poorer nations so that they could develop their economic resources for raising their standard of living.
3. 4.
5.
6. 7. 8. 9.
Organization and Management The IMF, an autonomous organization affiliated with United Nations, has its head office located in Washington. Thirty of the 44 countries represented at the Bretton Woods Conference became original members of the Fund by accepting its membership on or before December 31, 1945. The initial capital of the Fund was USD 8,800 million. Each member of the Fund was assigned a subscription quota based on its national income and its position in international trade. Every member country paid 25 per cent of its quota in gold or dollar and the balance in its national currency which was kept within the country itself in the name of the Fund and has periodical reviews of the subscription quotas.
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The organizational structure of the Fund has undergone important changes under the Second Amendment of the Articles of Agreement. The constitution and functions of each of these organs of the Fund are as follows: Board of Governors The highest authority and highest decision-making body of the Fund is the Board of Governors, consisting of one Governor and an alternate Governor for each member country. The member-country appoints the Governor who will usually be the Finance Minister or the Governor of the Central Bank of the country. The Executive Board The Board of Governors delegates the executive authority to the Board of Executive Directors. This Board consists of 24 executive directors of whom 6 are appointed, one each by the largest quotaholding countriesUSA, UK, Federal Republic of Germany, France, Japan and Saudi Arabiaand others are elected by different regional groups of member-countries. The Executive Board meets two or three times each week to consider day-to-day problems. The chairman of the Board of Executive Directors is the Managing Director, who will be the executive head and head of the staff of the Fund. He holds office for a term of five years. The Interim Committee The Interim Committee of the Board of Governors on the International Monetary System has an advisory body made up of 24 Fund Governors, Ministers, etc., and the committee normally meets twice a yearin April or May and at the time of the Annual meeting of the Board of Governors in September or October. The Interim Committee advises and reports to the Board of Governors on issues regarding the management and adaptation of the International Monetary Systemincluding sudden disturbances that might threaten the international monetary systemand proposals to amend the Articles of Agreement. The Development Committee The Development Committee (also known as the joint Ministerial committee of the Boards of Governors of the World Bank and of the IMF on the transfer of real resources to developing countries} comprising of 24 members (same as the interim committee advises and reports to the Board of Governors of the World Bank and of the Fund on all aspects of the transfer of real resources to developing countries. The Managing Director of the Fund and the President of the Bank participate in its work. The Fund operates through the General Account and the Special Drawing Account. It also administers some special Accounts and Trusts.
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Functions or Working
The main purposes for which the IMF has been set up are to provide exchange stability, temporary assistance to countries falling short of foreign exchange and sponsoring of international measures for curing fundamental causes of disequilibrium through avoiding competitive exchange depreciation and through the conversion of national currencies into one another. In order to achieve these objectives, the Fund performs the following functions: Maintaining Exchange Stability The main arrangement made by the Fund was to ensure stability in the exchange rate and to discourage fluctuations in the exchange rate. Each member-country declares par value of its currency in terms of gold as a common denominator or in terms of U.S. dollars. Members agree to keep up the free convertibility of their currencies at not more than 1% above or below its par value. Members are allowed to devalue up to 10%, if necessary, by merely informing the Fund. Greater or subsequent change requires the approval of the Governing Body. Multiple exchange rates of members are not allowed. Members are forbidden to buy or sell gold at prices other than the declared par value. The Fund provides financial assistance to member-countries to meet temporary deficits in their balance of payments, thereby acting as an international lender of last resort.
Determination of Par Values The Original Articles allowed the member countries to make adjustments in the par value of their currencies for correcting disequilibrium in their balance of payments. A country can make adjustments up to 10% by simply informing the IMF. However, for changes more than 10%, but below 20%, the approval by the two-third members of the Fund was necessary. The revised Articles of Agreements of the IMF has given the member-countries autonomy regarding exchange arrangements. The exchange rates are allowed to float or change according to the demand and supply conditions in the exchange market and also on the basis of internal price levels. The Articles require the IMF to exercise surveillance to ensure proper working of the international monetary system to maintain stability of exchange rates. The IMF provides machinery for international consultations by bringing together representatives of the principal countries of the world and affords excellent opportunity for reconciling their conflicting claims. This approach not only has stabilizing influence on world economy but also helps in balanced development
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and growth of world trade and production. To achieve this, the Fund conducts periodic study and research relating to urgent and important economic problems of the world. Financing Facilities The Fund provides financial support to its members depending upon the nature of the macro-economic and structural problems. In order to help the member-countries to correct disequilibrium in their balance of payments, the IMF operates various borrowing facilities: 1. Basic Credit Facility. The IMF provides financial assistance to its member-nations to overcome their temporary difficulties relating to balance of payments. To finance payment deficits, membernations in exchange for its own currency can purchase SDRs from the Fund. The loan will be repaid when the member repurchases its own currency with other currencies or SDRs. A member can unconditionally borrow from the Fund in a year equal to 25% of its quota. This unconditional borrowing right has been called the reserve tranche. In addition, four tranches (each equal to 25% of the quota) are available to a country. Thus, a member-country has the basic credit facility of 5 tranches (i.e., 125 % of its quota) from the Fund. However, borrowings by member-countries from the IMF should not be more than 200% of its quota. Standby Arrangements. The member-country was allowed to draw upon the resources of IMF up to specific limits and within an agreed period under standby system brought into force in 1952. The IMF extends to its member-country the facility of drawing funds as and when required. Such standby arrangements are negotiated between the IMF and individual members. Once the arrangement has been agreed, the request of a member for accommodation should be allowed by IMF without reconsideration of the members position at the time of drawing. The advantage under the facility was that the countries are assured of the assistance without the Fund imposing strict exchange and trade controls. Compensatory Financing Facility. IMF established compensatory financing facility in 1953 to provide additional assistance to the member-countries, particularly primary producing countries facing shortfall in export earnings. In 1981, the coverage of the compensatory financing facility was extended to payment problem caused by the fluctuations in the cost of cereal inputs. Buffer Stock Facility. The buffer stock financing facility was created in 1969 to help the primary producing countries to finance contributions to buffer stock arrangements for the stabilization of primary product prices. Extended Fund Facility. Established in September 1974 to assist the member-countries with severe balance of payments problem for long periods, IMF provided additional borrowing facility up to 140% of the members quota, over and above the basic credit facility. The extended facility was limited for a period up to 3 years and the rate of interest was low, i.e., from 4% to 6.5%. Supplementary Financing Facility. There was an urgent need for a supplementary facility of a
2.
3.
4.
5.
6.
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temporary nature that would enable the Fund to expand its financial assistance to those of its members facing payments imbalances larger in relation to their economies and quotas in the Fund. An agreement was reached in 1977 among 14 willing potential lenders to lend a total of SDR 7.8 billion for a supplementary financing facility in the Fund which became operational in May 1979. 7. Trust Fund. Part of the profits earned by selling gold in public auctions at prices much above the price prevailing in the market has been used to establish a Trust Fund in 1976 for making conditional loans to the less-developed countries with payments problems. Structural Adjustment Facility (SAF). This facility established in March 1986 provided additional balance of payments assistance on concessional terms to the poorer member-countries to undertake strong macro-economic and structural programmes. Enhanced Structural Adjustment Facility (ESAF). The IMF established this new facility in December 1987 from which its poorest member-countries can draw when undertaking strong three-year macro-economic and structural programmes. This facility was similar to SAF with regard to interest and repayment.
8.
9.
10. Supplemental Reserve Facility (SRF). This facility approved on December 17, 1997, was committed for a period of up to one year and was generally available in two or more branches. The IMF determined the amount of financing available under the SRF by taking into account the financing needs of the member; its capacity to repay including in particular the strength of economic programme; its outstanding use of IMF credit; and its record in using IMF resources in the past and compliance with the IMFs liquidity. Borrowing countries under the SRF are expected to repay within one to one and a half years from the date of each disbursement, though the Executive Board has authority to extend the period for repayment by up to one year, at which point the borrower will be obliged to pay during the period. 11. Poverty Reduction and Growth Facility (PRGF). An IMF objective of concessional lending was modified in 1999 to include an explicit focus on poverty reduction in poor member-countries. The IMF established the PRGF in place of Enhanced Structural Adjustment Facility (ESAF) to provide financing based on poverty reduction. The number of PRGF-eligible countries are 80 (reduced to 77 in 2000-01) with IMFs total commitments of SDR 3.3 billion. Special Drawing Rights (SDRs) The creation of Special Drawing Rights (SDRs) as an international reserve asset by the Fund was a significant attempt to reform the international monetary system and to solve the problem of international liquidity. In September 1967, in IMF meeting at Rio de Janeiro, an outline for a scheme of Special Drawing Rights was pushed forward. The amendment to the IMF Articles of Agreement was submitted to the members in 1968 and the draft amendment was ratified by July 1969. Every member of the IMF has the right to become a participant of the SDR facility, but every member was not obliged to join the facility, only members of the IMF can participate in SDR facility.
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SDR or the so-called paper-gold takes the form of a credit entry in the name of the participant countries in the Special Drawing Account of the IMF The newly created SDRs were allocated to the participating countries in proportion to their quotas in the IMF. Special Drawing Rights allocated and credited to a participants account was owned by it and they can be freely used by the said country for meeting payments deficits. One distinct characteristic of SDRs was its unconditional use. Originally one SDR was considered equivalent to 0.88671 gram of gold, equal to the value of one US dollar. Subsequent to the abandonment of the system of par values of currencies and floating of US dollar and other major currencies in 1973, it was decided to determine the value of SDR on the basis of a basket of 16 most widely used currencies of the United States, Britain, Germany, Japan, France, Canada, Italy, the Netherlands, Belgium, Sweden, Australia, Spain, Norway, Austria, Denmark and South Africa. Each of these currencies was assigned weight in proportion to its importance in international trade and world financial markets. To facilitate proper valuation of a unit of SDR, the number of currencies in the basket was reduced from 16 to 5 in January 1981. These currencies included the US dollar, the German deutsche mark, the British pound, the French franc and the Japanese yen. From January 1986, the currency composition of the basket of currencies and weightage to be assigned to each currency of the basket for the valuation of a unit of SDR was to be revised every five years. The revision of value of SDR was to be made on the basis of value of exports and balances of currencies held with the IMF by the member-countries. The agreed currency weight in SDR basket effective since January 1, 2001 was: US dollar45%; Euro29%; Japanese yen15%; and Pound sterling11%. Uses of SDRs Three principal uses of SDRs are, 1. The IMF designates a participant in the SDR scheme with strong and favourable balance of payments and reserve position to provide its currency in exchange of SDRs to another participant who requires its currency to meet adverse balance of payments. The SDRs are used in all transactions with the IMF The SDRs are used also in the transactions by agreement. The IMF permits the sale of SDRs for currency by agreement with another participating country in the scheme
2. 3.
Additional uses of SDRs The Second Amendment has empowered the IMF to employ SDRs in Swap arrangements, forward operations, granting and receiving of loans, settlement of financial disputes, security for financial obligations and granting of donations. The International Monetary Fund has played a very vital role in the stabilization of exchange system, in
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facilitating international payment adjustments and in the promotion of steady expansion of international trade and productive capacities of the member-countries. Achievements 1. (i) The Fund has been able to promote exchange stability with managed flexibility. It has allowed the variations in exchange rates by 1 per cent The World Bank
The World Bank Group of international financial institutions was concerned with assisting its membercountries to achieve sustained economic growth. It functions as an intermediary in the transfer of resources from the more developed to the less developed countries to enable efficient use of capital for economic and social development. There are three affiliates of the World Bank/IBRDThe International Development Association (IDA), the International Finance Corporation (IFC) and Multilateral Investment Guarantee Agency (MIGA). The main features of these financial institutions are discussed below, (ii) International Bank of Reconstruction and Development (IBRD) The International Monetary Fund (IMF) and the International Bank of Reconstruction and Development (IBRD), popularly known as the World Bank, is the twin institutions set up at the United Nations Monetary and Financial Conference held at Bretton Woods, New Hampshire, in July 1944. While the IMF was established to provide short-term loans to overcome the balance of payments difficulties, the World Bank was aimed at providing long-term loans for the purpose of (i) reconstructing the wardamaged economies, and (if) developing the less developed economics. The IBRD started operations in June 1946. Objectives of IBRD The IBRD was established to promote long-term foreign investment loans on reasonable terms. The purposes of the IBRD, as set forth in the Article I of the Agreement are as follows: 1. 2. To assist in the reconstruction and development of territories of members by facilitating the investment of capital for productive purpose including: the restoration of economies destroyed or disrupted by war (hence the name Bank for Reconstruction); the reconversion of productive facilities to peaceful needs; and the encouragement of the development of productive facilities and resources in less developing countries (hence the name Bank for Development). To promote private investment by means of guarantee or participation in loans and other investments made by private investors.
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3.
When private capital was not available on reasonable terms, to supplement private investment by providing on suitable conditions finance for productive purpose out of its own capital funds raised by it and its other resources. To promote the long-range balanced growth of international trade and the maintenance of equilibrium in balance of payments by encouraging international investment for the development of the productive resources of members, thereby assisting in raising productivity, the standard of living, and conditions of labour in their territories. To arrange the loans made or guaranteed by it in relation to international loans through other channels so that the more useful and urgent projects, large and small alike, will be dealt with first. To conduct its operations with due regard to the effect of international Investment on business conditions in the territories of members and in the
4.
5. 6.
Organization and Management The countries which were initially members of the IMF could become the members of the World Bank, but, later on, this restriction to membership was relaxed. Any country can now become a member of the Bank if its application is supported by 75% of the existing members, and a member can withdraw from the bank by sending a written notice. The Bank can also suspend a member who violates its rules. IBRD was owned by the Governments of 183 countries that have subscribed to its capital. The initial authorized capital of the World Bank was USD 10,000 million, divided into 1,00,000 shares of USD 1,00,000 each. These shares were available only to member-countries. Of each share (a) 2% payable in gold or U.S. dollars; 18% to be paid in the currency of the member-country; and (c) the remaining 80% as callable fund, i.e., it was liable to be called if and when needed to meet obligations to lenders from whom the Bank has borrowed or to private investors whose loans the Bank has guaranteed. Thus, only 20% of the total capital was called up by the Bank and made available for lending purposes. As on June 2001, the total authorized capital of 183 member-countries was over USD 189.5 billion. All powers of the Bank are vested in a Board of Governors consisting of one representative appointed by each country and which meets normally once a year. The Governors have delegated most of their powers to a Board of Executive Directors which usually meets once a month. There are at present 24 Executive Directors five are appointed by the five nations having the largest capital subscriptions (U.S.A., Japan, Germany, United Kingdom, and France) and 19 arc elected by the Governors of the remaining members for a two-year term. The President of the Bank was the Chairman of the Board of Executive Directors. The voting powers of the Executive Directors are proportionate to the capital subscriptions of the country or countries which they represent. The Executive Directors are responsible for matters of policy and must approve all IBRD loans and IDA credits. The Executive Directors are also responsible for deciding policy issues that guide the general operations of the Bank and its direction. The day-to-day conduct of the Banks operations, including the making of recommendations to the Executive Directors on loans and questions of policy, is the responsibility of the President.
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Lending Activities of IBRD
The Bank lends to its member-countries in any of the following three ways: (i) Lend directly from own funds. The Bank was authorized to grant loans up to 20 per cent of its subscribed capital to member-countries2 per cent of the subscribed capital kept in the form of gold in any way it likes, and the remaining 18 per cent lending only on obtaining the approval of the respective member whose currency has to be lent. (ii) Loans from other sources. To advance loans to member-countries, the Bank may also take loans from funds of other countries with approval of the lender country to give loan to another membercountry. (iii) Guarantee of loans. The most significant activity of the Bank was that it may guarantee loans from private investors to its members, and thus encourage private capital investment. But in such cases the Bank has to take the approval of both lender and borrower.) Conditions for Loans Before the World Bank provides a loan, either directly or indirectly through guarantee, certain conditions must be fulfilled. These, conditions, as stated in the Article III of the Articles of Agreements, require that: a) The World Bank lends only to governments or have guarantee of the government in whose territory the borrower is located as to the repayment of the principal and the payment of the interest and other charges. The competent committee of the World Bank reports favourably on the project. The World Bank is satisfied that the borrower is unable to obtain the loan otherwise on reasonable terms. In the opinion of the World Bank, the rate of interest and other charges are reasonable and such rate, charges and the schedule for repayment of principal are appropriate to the project. In guaranteeing a loan made by other investors, the World Bank receives suitable compensation for its risk.
b) c) d) e)
Operations of IBRD The lending operations of the IBRD, since its inception in 1946, concentrated heavily upon the provision of capital for infra-structural projects such as roads and railways, generation and distribution of electricity, irrigation projects, ports development, telecommunications, etc. for the first two decades. Since 1970, the emphasis in its lending operations has shifted from infrastructural projects to the financing of educational system in developing countries, creation of institutions for financing industrial investment
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and provision of technical assistance for the selection and appraisal of industrial projects and to assist in the preparation of agricultural projects. The Banks lending policy since 1973 was directed towards the reduction of the massive dimensions of absolute poverty. Most of the loans were allocated for rural development projects whose objective was to benefit people in the bottom, 40 per cent income group. The Bank in 1975 also announced that it would try to deal with the problems of urban poor and urban unemployed. The Bank in 1979 announced that it would increase substantially its assistance for the production and acceleration of oil and natural gas in the developing countries during the early eighties. A new lending programme introduced in 1980 was directed towards structural adjustments by the developing countries. According to this policy the Bank supports programmes of specific policy changes and institutional reforms in developing countries designed to achieve a more efficient and meaningful use of resources. Certain modification was approved by the Executive Board in 1981 on repayment terms. They are shifting repayment of new loans for low-income countries, to annuity, extension of grace period through fiscal year 1991 on new loans to middle-income countries from 3 to 5 years and review of repayment terms for middle-income countries within three years. A Special Action Programme (SAP) was started by the Bank in 1983 to provide assistance to the members for adjusting to the current economic environment. Four major elements of the programme are(i) enhanced lending for high priority operations that support structural adjustment, policy changes, production for export, maximum use of existing capacity and the maintenance of crucial infrastructure; (ii) enhanced disbursements under existing and new investment commitments for the timely execution of high priority projects; (Hi] extension of advisory services on the design and implementation of appropriate policies which include reviews of State enterprises, studies to strengthen development orientation and project implementation capabilities, studies to increase the mobilization of domestic resources, reviews of incentives for export diversification and exploration of ways to strengthen debt management capabilities; and (iv) seeking cooperation of other donors for fast disbursing assistance in support of programmes of the Bank and IMF. During the fiscal year 1989 new commitments amounted to USD 16.4 billion as against USD 14.8 billion in 1988. Now lending commitments declined by USD 1.2 billion to 15.2 billion in 1990. Total commitments during 1990 to 1994 amounted to USD 78 billion, showing an annual average of USD 15.6 billion which was higher as compared to the preceding period of five years. Commitments during 1994 at USD 14.2 billion were, however, lower by USD 2.8 billion as compared to commitments amounting to USD 17.0 billion during 1993. Total disbursements for the period 1990-94 amounted to USD 60.4 billion. Disbursements during 1994 amounted to USD 10.5 billion as compared to USD 12.9 billion in 1993. During the fiscal year 1995 lending commitments of the IBRD amounted to USD 16.853 million, showing an increase of 18.3 per cent over the previous year, in 1996 it amounted to USD 14,656
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million showing a decline of 13 per cent, in 1997 it declined by 0.9 per cent. Gross disbursements by the IBRD in 1995, 1996 and 1997 amounted to 12,672 million, 13,372 million and 13,998 million respectively, showing an increase of .21.3 per cent, 5.5 per cent and 4.7 per cent over the previous years respectively. New lending by IBRD in fiscal year 2002 at USD 11.5 billion was USD 1 billion above the previous years level. The number of new operations approved was higher than last year at 96. New IBRD lending to Europe and Central Asia reached a record high of USD 4.9 billion, or 43 per cent of total IBRD commitments, followed by Latin America and the Caribbean with USD 4.2 billion. The East Asia and Pacific region was third with USD 1 billion. The prevalent themes correlated to the sector lending, with a major focus on strengthening the financial and private sector regulatory framework and improving public sector governance. Human development, economic management, and urban development were also supported. Public administration was by far the leading sector for IBRD lending, receiving USD 3.6 billion, over 30 per cent of the total. The significant amount of lending in the public administration sector reflects the Banks focus on assisting its clients to improve development strategies, implement reform policies, and build institutional capacities. Lending to the finance sector was second, representing USD 2.1 billion, about 18 per cent of the total. The share of adjustment lending by IBRD rose to a record high of 64 per cent in fiscal 2002, compared with 38 per cent in fiscal 2001, and with 47 per cent and 63 per cent during the East Asian crisis years of fiscal 1998 and 1999, respectively. Argentina, Brazil, Jamaica, Tunisia, Turkey and Ukraine are among the countries where Bank lending sought to alleviate the effects of falling export demand, commodity prices, and capital market access.
3.6 Government Institutions

Governments act in various ways as actors in the GFS: they pass the laws and regulations for financial markets and set the tax burden for private players, e.g., banks, funds and exchanges. They also participate actively through discretionary spending. They are closely tied (though in most countries independent of) to central banks that issue government debt, set interest rates and deposit requirements, and intervene in the foreign exchange market. Private participants Players acting in the stock-, bond-, foreign exchange-, derivatives- and commodities-markets and investment banking are Commercial banks Hedge funds and Private Equity Pension funds
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Legal frameworks and treatises Commonwealth of Independent States (CIS) Eurozone Mercosur North American Free Trade Agreement (NAFTA)
Perspectives There are three primary approaches to viewing and understanding the global financial system. The liberal view holds that the exchange of currencies should be determined not by state institutions but instead individual players at a market level. This view has been labelled as the Washington Consensus. This view is challenged by a social democratic front which advocates the tempering of market mechanisms, and instituting economic safeguards in an attempt to ensure financial stability and redistribution. Examples include slowing down the rate of financial transactions, or enforcing regulations on the behaviour of private firms. Outside of this contention of authority and the individual, neoMarxists are highly critical of the modern financial system in that it promotes inequality between state players, particularly holding the view that the political North abuses the financial system to exercise control of developing countries economies.
3.7 Foreign Financial Market & Exchange Determination

Nearly all international business activity requires the transfer of money from one country to another Trade transactions must be settled in monetary terms: Buyers in one country pay suppliers in another. Repatriation of dividends, profits, and royalties from overseas investments, contributions of equity and other kinds of financial dealings from such investments also involve the transfer of funds across national borders. The transfer of funds poses problems quite different from those associated with the transfer of goods and services across national borders. Buyers and sellers are willing to accept and use goods and services from other countries quite routinely. For example, U.S. consumers are content to drive Japanese cars, such as Toyotas and Hondas, while the Japanese are quite willing to use U.S. operating systems or other hi-tech products. This internationalization that applies to product usage is not found when it comes to accepting the currency of another country, however. While the U.S. importer is happy to receive Japanese products and the Japanese importer is glad to accept U.S. products, neither is normally in a position to accept the others currency. A U.S. importer usually has to pay a Japanese exporter in Japanese yen, while a U.S. exporter will generally want to be paid in U.S. dollars. This is quite logical, since each country has its own currency, which is legal tender within its borders, and exporters are likely to prefer the currency that they can use at home for meeting costs and taking profits.
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A U.S. importer who must pay a Japanese exporter has to acquire Japanese yen. To do so, he must exchange his own currency, dollars, into yen. Such an exchange of one currency for another is called a foreign exchange transaction. For example, a German company invests in an electronics manufacturing facility in Australia. Therefore, it must convert its euros into Australian dollars to meet project costs in Australia. In another example, a U.S. multinational has a plant located in Great Britain. At the end of the financial year, it wants to repatriate its profits to corporate headquarters in the United States. Therefore, it will convert British pounds sterlingprofits earned by the plant in Great Britaininto U.S. dollars. As another example, suppose a Japanese investor has a large stock holding on Wall Street. After a rally in which his holdings appreciate substantially, he wants to repatriate his profits to Japan. To do so, he would convert his U.S. dollar profits into Japanese yen. How do the German company, the U.S. multinational, and the Japanese investor convert the currency in their possession into the currency they desire? The answer is provided by the foreign exchange markets. The Structure of the Foreign Exchange Markets The demand for conversion of one currency into another currency give rise to the demand for foreign exchange transactions. The foreign exchange markets of the world serve as the mechanism through which these numerous and complex transactions are completed efficiently and almost instantaneously. The main intermediaries in the foreign exchange markets are major banks worldwide that deal in foreign exchange. These banks are linked together by a very advanced and sophisticated telecommunications network that connects them with major clients and other banks around the world. There is no physical contact between the dealers of various banks in the foreign exchange markets, unlike in the stock exchanges or the futures markets, which have specific trading floors or pits. Some of the larger and more active banks have installed computer terminals called dealing screens in their trading rooms. Through these terminals, banks can execute trades and receive written confirmations on online printers. Telephone transactions are normally confirmed by an exchange of telex messages or transaction notes. Banks that are active in foreign exchange operations set up extremely sophisticated facilities for their foreign exchange traders; these facilities are located in trading (or dealing) rooms, which are equipped with instantaneous telecommunication facilities. A very important feature of modern trading rooms is their access to information about political, economic, and other current events as they unfold. A major source of this information is the British news agency Reuters, which furnishes subscribing banks with a dedicated communication system that provides onscreen information beamed from the central newsroom of the agency. There are also many services, including Reuters and Telerate that provide up-to-the-second information on the prevailing exchange
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rates quoted by banks worldwide. Any changes in exchange rates anywhere in the world can be immediately brought to the notice of traders. Exchange trading is an extremely specialized operation that puts enormous pressure on traders because rates change rapidly and there are chances to make huge profits or incur massive losses. Bank management continually monitors the activity and progress of its dealing rooms, while setting very clear guidelines in order to limit the level of risk the traders can take while trading currencies on behalf of the bank. To relieve traders from the task of booking orders, trading rooms are supported by backup accounting departments that record the transactions made by the traders and that do the necessary computations to track the trading activity. They also supply the traders with background data and analytical reports to optimize the traders strategy and performance. Such information is fed into electronic trading boards that are clearly visible to traders. Generally, this information includes the risk exposure of the bank in each currency and the current rates for different currencies, as well as a host of other information. Exchange trading at a bank usually begins every day in the early morning with an in-house conference of traders and senior managers to discuss the currency expectations and the strategy for the day. Most trading is conducted during local business hours, but the ease of communication made possible by the latest technology enables banks to continue to trade with banks in other time zones after the local business day is over. Therefore, some major banks have a system of shifts, through which traders come in to trade in markets in different time zones. By using night trading desks, many major banks have been able to establish 24-hour trading operations. There are two levels in the foreign exchange markets. One is the customer, or retail, market, in which individuals or institutions buy and sell foreign currencies to banks dealing in foreign exchange. For example, if IBM wishes to repatriate profits from its German subsidiary to the United States, it can approach a bank in Frankfurt with an offer to sell its euros in exchange for U.S. dollars. This type of transaction occurs in what is called the customer market. Suppose the bank does not have a sufficient amount of U.S. dollars to exchange for the subsidiarys euros. In this Situation the bank can approach other banks to acquire dollars in exchange for euros or some other currency. Such sales and purchases are termed inter-bank transactions and collectively constitute the inter-bank market. Inter-bank transactions are both local and international. The inter-bank market is extremely active. Banks purchase currencies from and sell currencies to one another to meet shortages and reduce surpluses that result from transactions with their customers. Transactions in the inter-bank markets are almost always in large sums. Amounts less than US$250,000 are not traded in inter-bank markets. Values of inter-bank transactions usually range from US$1 million to US$10 million per transaction, although deals involving amounts above this range are also known to take place. A large proportion of the transactions in inter-bank markets arise from banks trading currencies to make profits from movements in exchange rates around the world.
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It is important to note that in all this trading activity in foreign exchange markets, billions of dollars of international currency are exchanged without any physical transfer of money. How are the transactions settled? The answer lies in a system of mutual account maintenance. Banks in one country maintain accounts at banks in other countries. These accounts are generally denominated in the home currency of the bank with the account. In banking parlance these are called vostro accounts, which essentially means your account with us, or nostro accounts, which means, literally, our account with you. Thus, if Citigroup New York has a euro account with Dresdner Bank in Frankfurt, it will term the Dresdner account its nostro account. For Dresdner, this will be a vostro account. Similarly, Dresdner Bank would have a U.S. dollar account with Citibank or another bank in the United States. For Dresdner this will be a nostro account, while for the U.S. bank it will be a vostro account. Foreign exchange transactions are settled by debits or credits to nostro and vostro accounts. Market Participants The foreign exchange markets have many different types of participants. These participants differ not only in the scale of their operations but also in their objectives and methods of functioning. Individuals Individuals may participate in foreign exchange markets for personal as well as business needs. An example of a personal need would be sending a monetary gift to an overseas relative. To send the gift, the individual would utilize the market to obtain the currency of the relatives country. Individual business needs arise when a person is involved in international business. For example, individual importers use the foreign exchange markets to obtain the currencies needed to pay their overseas suppliers. Exporters, on the other hand, use the markets to convert the currencies received from their foreign buyers into domestic or other currencies. Business or leisure travelers also participate in the foreign exchange markets by buying and selling foreign and local currencies to meet expenses on their overseas trips. Institutions Institutions are very important participants in the foreign exchange markets because of their large and varied currency requirements. Multinational corporations typically are major participants in the foreign markets, continually transferring large sums of currencies across national borders, a process that usually requires the exchange of one currency for another. Financial institutions that have international investments are also important foreign exchange market participants. These institutions include pension funds, insurance companies, mutual funds, and investment banks. They need to switch their multicurrency investments quite often, generating substantial transaction volumes in the foreign exchange markets. Apart from meeting their basic transaction needs, both the individual and institutional participants use the foreign exchange markets to reduce the risks they incur because of adverse fluctuations in exchange rates.
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Banks Banks are the largest and most active participants in the foreign exchange markets. Banks operate in the foreign exchange markets through their traders. (British banks and many others use the term exchange dealer rather than exchange trader. These terms can be used interchangeably.) Exchange traders at banks buy and sell currencies, acting on the requests of their customers and on behalf of the bank itself. Customer-requested transactions form a very small proportion of trading operations by banks in the foreign exchange markets. To a very large extent, banks treat foreign exchange market operations as an independent profit center. In fact, some major banks make substantial profits on the strength of their market expertise, information, trading-skills, and ability to hold on to risky investments that would not be feasible for smaller participants. On occasion, banks can also incur substantial losses. As a result, foreign exchange operations are closely monitored by bank management teams. Central Banks and Other Official Participants Central banks enter the foreign exchange markets for a variety of reasons. They can buy substantial amounts of foreign currencies to either build up their foreign exchange reserves or bring down the value of their own currency, which in their opinion may be overvalued by the markets. They can enter the markets to sell large amounts of foreign currencies to shore up their own currencies. In the latter part of the 1980s, central banks and treasurers of the United States, Japan, and the then West Germany intervened quite often to correct the imbalances between the values of the yen and deutsche mark (then the currency of West Germany; the unified Germany now uses the Euro) versus the U.S. dollar. The main objective of central banks is not to profit from their foreign exchange operations or to avoid risks. It is to move their own and other important currencies in line with the values they consider appropriate for the best economic interest of their country. Central banks of countries that have an official exchange rate for their currency must continually participate in the foreign exchange markets to ensure that their currency is available at the announced rate. Speculators and Arbitragers Participation by speculators and arbitragers in the foreign exchange markets is driven by pure profit motive. These traders seek to profit from the wide fluctuations that occur in foreign exchange markets. In other words, they do not have any underlying commercial or business transactions that they seek to cover in the foreign exchange market. Typically speculators buy large amounts of a currency when they believe it is undervalued and sell it when the price rises. Arbitrage occurs when investors try .to exploit the differences in exchange rates between different markets. If the exchange rate for the pound is cheaper in London than in New York, they would buy pounds in London and sell them in New York, making a profit. Arbitrage opportunities are now increasingly rare, however, because instantaneous communications tend to equalize worldwide rates simultaneously.
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A substantial part of the speculative and arbitrage transactions comes from exchange traders of commercial banks. Often these transactions represent a conscious effort to maximize profits with clearly defined profit objectives, loss limits, and risk-taking boundaries. In fact, the overwhelming proportion of foreign exchange market transactions today is driven by speculation. Foreign Exchange Brokers Foreign exchange brokers are intermediaries who bring together parties with opposite and matching requirements in the foreign exchange markets. They are in simultaneous contact through hotlines with scores of banks, and they attempt to match the buying requirements of some banks with the selling needs of others. They do not deal on their own account and are not a party to the actual transactions. For their services they charge an agreed-on fee, which is often called brokerage. By bringing together various market participants with complementary needs, foreign exchange brokers contribute significantly to the perfection of information, which makes the foreign exchange markets as efficient as they are. Apart from this, brokers also perform another important function. They preserve the confidentiality and anonymity of the participants. In a typical deal, the broker will not reveal the identity of the other party until the deal is sealed. This achieves a more uniform conduct of business as deals are decided purely on market considerations and are not influenced by other considerations that might be introduced if the parties identities became known. Location of Foreign Exchange Markets The foreign exchange markets are truly global, working around the clock and throughout the world. The very nature of foreign exchange trading, as well as the revolution in telecommunications, has resulted in a unified market in which distances and even time zones have been compressed. Traditionally, London and, later, New York were the main centers of foreign trading. Other centers, however, such as Tokyo, Hong Kong, Singapore, and Frank-fort, have become extremely active. Smaller but significant markets exist in many European and some Asian countries. The individual foreign exchange trading centers are closely linked to form one global market. Trading spills over from one market to another and from one time zone to another. Price levels in one trading center immediately affect those in other centers. As the market closes in one time zone, others open in different time zones, taking cues from the activities of the earlier market in setting up trading and price trends. A continuous pattern is thus established, giving the impression of one unified market across the world. Japan Because of its geographical position, Japan can be considered the market where the worlds trading day begins. The Japanese markets, led by Tokyo, are extremely active, with a very high daily turnover. Most of the deals are backed by customer-related requests to finance or settle international commercial
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transactions. Dollar-yen deals predominate in the market, because of the large share of U.S. related business in the international transactions of Japan. Since the deregulation of Japanese foreign exchanges, the element of speculative activity has increased considerably, especially in the Tokyo market. The volume of trading in the market has also increased as the securities and equity markets of Japan have opened up to foreign investment and some foreign investment banks have been allowed to operate in Japan. Brokers are extensively used in the Japanese markets, especially in transactions between banks located within the country. The market, however, closes at a set time in the afternoon, thus putting a limit on the volume of transactions that can take place. This system has inhibited somewhat the development of the Tokyo market, which would otherwise be significantly larger. Singapore and Hong Kong Singapore and Hong Kong are the next markets to open, about one hour after Tokyo. These markets are much less regulated, and in pursuit of their aim to become major international financial centers, both markets offer liberal access to overseas banks and commercial establishments. At the same time, the governmental authorities have attempted to create a friendly market environment to promote maximum trading activity. Market activity has increased considerably because several overseas banks, attracted by the incentives offered, have opened branches in both centers. Brokers are heavily involved in local transactions in Singapore, while international transactions are handled primarily through direct deals between banks. The trading activity of Hong Kong is a mix of direct deals and broker-intermediated transactions. Both of these markets have grown tremendously in the past few years. Bahrain The Bahrain market in the Middle East emerged as an important center of foreign exchange trading in the 1970s, as oil-linked commercial transactions grew considerably. Located in the middle of overlapping time zones, Bahrain is often used by traders in other markets to serve as a link in their global cycle. Bahrain provides a bridge between the closing of the Far Eastern and opening of the European markets because it is open during the time when the markets in those locations are closed. European Markets Europe, taken as a whole, is the largest foreign exchange market. Its main centers are London, Frankfurt, and Zurich. European banks have no set closing time for foreign exchange trading and are free to trade 24 hours a day, but they generally cease trading in the afternoon. Both direct and brokered deals are common in European trading. In the past, some of Europes markets, such as that in Paris, have exhibited a unique feature: rate fixing. Once a day, representatives of the larger banks and the central banks met to fix the exchange rate of the U.S. dollar against local currencies and hence against one another. The fixed rate represented the balance of offers and bids and was close to what the rate would be internationally. There was sometimes a small discrepancy, however, which offered an opportunity for
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arbitrage. This opportunity, of course, existed for only a very short time, as market pressures quickly equalized the prices. The fixed rate was important primarily because it was considered to be the legal official rate and was often specified in contracts. This practice is less important in the European markets now, given that many of the countries are using the same currency (the Euro). U.S. Markets The New York market opens next. It is one of the worlds largest markets, and the top foreign exchange trading firms are headquartered there. The volume of business in New York has increased tremendously since deregulation of the banking system and the increasing presence of overseas banks. Both brokered as well as direct dealing are common in the New York exchange market. The West Coast markets are essentially tied to New York and closely follow the trading patterns that are established there. Market Volumes Foreign exchange markets are clearly located in the largest financial markets in the world. Their turnover exceeds several times that of securities, futures, options, and commodities markets. The actual turnover figures, however, are difficult to ascertain, because banks do not publish data on the volume of their transactions. In 1979 one study estimated the daily turnover of the world foreign exchange market to be about US$200 billion.1 A 1986 survey by the Federal Reserve Bank of New York put the daily turnover of U.S. banks at US$50 billion.2 Today, the estimated turnover is as much as US$ 1.5 trillion per day on a global level. The currencies that predominate in foreign exchange trading activity on a worldwide basis are the U.S. dollar, the euro, the yen, the Swiss franc, the pound, the Canadian dollar, and the Australian dollar. Some other currencies of increasing importance in foreign exchange markets are the Swedish krona, the Indian rupee, and the Chinese yuan. A daily turnover of US$ 1.5 trillion would amount to an annual figure of US$547.5 trillion. The enormity of this figure, which estimates the annual volume of global foreign exchange trading, can be appreciated if one compares it with the U.S. GNP, which was US$11.71 trillion in 2004. Uses of the Foreign Exchange Market The foreign exchange market provides the means by which different categories of individuals and institutions acquire foreign exchange to meet different needs, but it is important to understand the economic functions performed by the foreign exchange markets and their role in international trade in goods and services. Two basic functions are the avoidance of risk and the financing of international trade. International trade transactions, which must be settled monetarily, carry significant risks both to the buyer and to the seller. If the transaction is invoiced in the currency of the seller, the seller stands to lose if the currency depreciates in the time lag between agreement on the price and the actual date of
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payment. Consider, for example, a British importer of U.S. computers. The importer agrees to buy the shipment of computers for US$150,000, and the current exchange rate is US$1.5 to 1. At this rate, the cost to the British importer is 100,000. Usually, in such instances payments are made after goods are shipped or received. In this example assume a lag of three months between the signing of the contract and the actual payment by the British importer. Suppose that in this period the value of the U.S. dollar appreciates and US$1 becomes equal to l. In this event, the British importer will have to part with 150,000 to purchase the US$ 150,000 needed to meet the contractual obligation. As a result, the importer stands to incur a substantial loss: 50,000. Although this is an exaggerated example, the risks are indeed real and can often wipe out the entire profit from a transaction. Foreign exchange markets provide mechanisms to reduce this risk and assure a certain minimum return. Foreign exchange markets also provide the financing mechanism for international trade transactions. Financing is required to cover the costs of goods that are in transit. These costs are considerable if goods are sent by sea. At the same time, the risks are also high because the parties are in different countries, and, in the event of default, the recourse for the party defaulted against is limited. These problems are solved efficiently through the foreign exchange markets, specifically through the use of internationally accepted documentation procedures, the most important being letters of credit. Types of Exposure in Foreign Exchange Markets There are four major types of risks or exposure that a corporation faces in the course of its international business activity: transaction exposure, economic exposure, translation exposure, and tax exposure. Transaction Exposure Transaction exposure is the risk that a companys future cash flows will be disturbed by fluctuations in exchange rates. A company that is expecting inflows of foreign currency will be faced with transaction exposure to the extent that the value of these inflows can be affected by a change in the rate of the companys currency against the preferred currency for conversion. Exchange rates are extremely volatile, and a sharp movement can adversely affect the real value of cash flows in the desired currency. A corporation can have both inflows and outflows in a currency. Moreover, it can have different amounts of inflows and outflows in different currencies. In this situation, the company nets out its exposure in each currency by matching a portion of its currency inflows and outflows. The net exposure in each currency is aggregated for all currencies to arrive at a measurement of the total transaction exposure for the company. The period over which the cash flows are considered for arriving at the figure for transaction exposure depends on the individual methods and views of the company. Organizations use a variety of methods to assess the degree to which their net exposed cash flows are at risk. These methods can center on the time lag between the initiation and completion of the transaction, the use of currency correlations, or statistical projections of exchange-rate volatility. Sophisticated strategies for assessing transaction exposure often include some element of all of these considerations.
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Economic Exposure
Economic exposure is a relatively broader conception of foreign exchange exposure. The prime feature of economic exposure is that it is essentially a long-term, multi-transaction-oriented way of looking at the foreign exchange exposure of a firm involved in international business. The standard definition of economic exposure is the degree to which fluctuations in exchange rates will affect the net present value of the future cash flows of a company. Economic exposure is a particularly serious problem for multinational corporations with operations in several different countries. Since currency fluctuations do not follow any set pattern, each operation is subject to a different degree and nature of economic exposure. Measuring the degree of economic exposure is even more difficult than measuring translation exposure. Economic exposure involves operational variables, such as costs, prices, sales, and profits, and each of these is also subject to fluctuation in value, independent of the exchange-rate movements. Many techniques are used to measure economic exposure. Most of these techniques rely on complex mathematical and statistical models that attempt to capture all the variables. Use of regression analysis and simulation of cash-flow positions under different exchange-rate scenarios are two examples of such techniques. Managing economic exposure can involve extremely complex strategies and instruments, some of which are outside the foreign exchange market. Translation Exposure Translation exposure is the degree to which the consolidated financial statements and balance sheets of a company can be affected by exchange-rate fluctuations. It is also known as accounting exposure. Translation exposure arises when the accounts of a subsidiary are consolidated at the head office at an exchange rate that differs from the rate in effect at the time of the transaction. Tax Exposure Tax exposure is the effect that changes in the gains or losses of a company because of exchange-rate fluctuations can have on its tax liability. An unexpected or large gain based solely on exchange-rate fluctuations could upset the tax planning of a multinational by causing an increased tax liability. Gains and losses from translation exposure generally have an effect on the tax liability of a company at the time they are actually realized. Types of Foreign Exchange Markets There are two main types of foreign exchange transactions that are often characterized as different marketsspot transactions and forward transactions. Often dealers specialize in one of three transaction categories: cash, tom, or spot.
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The Spot Market The spot market consists of transactions in foreign exchange that is ordinarily completed on the second working day of the deal being made. Within the spot market, there can be three types of transactions: 1. 2. 3. Cash, in which the payment of one currency and delivery of the other currency are completed on the same business day Tom(short for tomorrow), in which the transaction deliveries are completed on the next working day Spot exchange, in which the transaction deliveries are completed within the same day of the deal being struck
Price Quotation in Exchange Markets The prices of currencies in the spot market can be expressed as direct quotes or indirect quotes. When the price of one currency is expressed as a direct quote, it reflects the number of units of home currency that are required to buy the foreign currency. A direct quote on the New York market would be US$1.30 = 1. An indirect quote is the reverse; the home currency is expressed as a unit, and the price is shown by the number of units of foreign currency that are required to purchase one unit of the home currency. For example, in the New York market an indirect quote would be US$1= 0.77 (to purchase one unit of the home currency, the U.S. dollar, 0.77 are needed). An important feature of foreign exchange price quotation is the number of decimal used. Since large amounts are traded, quotes are usually given at least up to the fourth decimal, especially for such major currencies as the pound and the U.S. dollar. Thus, a quote for the pound would be 1 = US$1.7643. Long and Short Positions A bank can be in the spot market in three positions: 1. 2. 3. Long, when it buys more than it sells of a currency Short, when it buys less than it sells of a currency Square, when it buys and sells the same amount of currency
Whenever a bank is long or short in a currency, it is exposed to a certain amount of risk. The risk arises in a long position because the value of the banks excess currency could depreciate if that currency falls in price. Thus, the market value of the assets of a bank would be lower than the cost price. In a short position, the bank agrees to sell more currency than it has in its possession. If the price of the currency in which the bank is short rises, the bank will experience a loss. The bank will have to acquire and deliver the currency at a higher price than the agreed-on selling price. Both long and short positions can
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also result in profits, if the currency in question appreciates or depreciates. Since large losses are possible, banks must carefully evaluate the amount of exposure they can withstand. Specific limits are laid down for long and short positions in each currency, as well as aggregate limits for all major currencies. There are usually two types of trading strategy followed by banks in the spot market. One strategy is to determine whether the currency is going to appreciate or depreciate and then assume a long or short position, allowing the trader to profit from the currency movement. This strategy is often called running a position, or positions trading. The other strategy is to assume and liquidate long and short positions very quickly (often within minutes), as exchange rates fluctuate during the business day. This strategy is known as in-and-out trading. The Forward Market The forward market consists of transactions that require delivery of currency at an agreed -on future date. The rate at which this forward transaction will be completed is determined at the time the parties agree on a contract to buy and sell. The time between the establishment of contracts and the actual exchange of currencies can range from two weeks to more than a year. The more common maturities for forward contracts are one, two, three, and six months. Some forward transactions are termed outright forwards, to distinguish them from swap transactions. Forward transactions typically occur when exporters, importers, or others involved in the foreign exchange market must either pay or receive foreign currency amounts at a future date. In such situations there is an element of risk for the receiving party if the currency it is going to receive depreciates during the intervening period. For the purposes of a quick example of this concept, assume that the owner of a small business wished to purchase an amount of softwood lumber from a Canadian company in June 2004. At that time, the Canadian dollar was worth US$0.74. If the purchase had been made in June, the total purchase of Can$3,000 would have cost the business owner US$2,22O.00 (3,000. x0.74). If for some reason the business owner had waited until November 2004 to purchase the softwood lumber from the Canadian company, the Canadian dollar would have risen to US$0.84 by that time. Thus, the same Can$3,000 purchase would have cost the business owner US$2,520.00 (or US$300 more than the same product would have cost in June!). The owner of the small business could have eliminated all or part of this risk by purchasing a forward currency contract over this period of time.
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Table 2: Major Currency Cross Rates as of April 7, 2006 To fix a minimum value on the foreign exchange proceeds, these recipients can lock into a rate in advance by entering into a forward contract with a bank. Under such a contract, the bank is obligated to purchase the currency from the exporter at the agreed-on rate, regardless of the rate that prevails on the day when the foreign currency is actually delivered by the exporter. Banks in turn enter into contracts with other banks to offset these customer contracts, which give rise to inter-bank transactions in the forward market. The date on which the currencies are to be delivered under a forward contract is fixed in advance and is usually specific. In some customer contracts, however, the banks provide an option to the customers to deliver currencies within a certain time that can range up to 10, 20, or 30 days. The costs of such contracts are, naturally, higher than the cost of contracts with specific maturity dates, because banks have to incur additional costs and efforts to create offsetting contracts in the inter-bank market. Forward contracts are popular with customers who are not certain of the dates on which they will have to pay or receive foreign currency amounts and would therefore like some leeway in executing their contractual obligations. Foreign Exchange Rates A foreign exchange rate can be defined as the price of one currency expressed in units of another currency. The price of pounds expressed in terms of U.S. dollars could be 1.8391. Therefore, 1.8391 would be the foreign exchange rate of the pound. Many journals and newspapers report foreign exchange rates either daily or periodically. Table 2 shows the major currency cross rates on April 7, 2006 as shown on Yahoo Finance. Notice that you can determine both the direct and the indirect exchange rates for each of the currencies listed in the table.
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Since it is often confusing to decide whether a rate is an indirect or direct quote, a uniform standard of exchange-rate quotation was adopted in 1978. Under this standard, the U.S. dollar was to be the unit currency and other currencies were expressed as variable amounts relative to the U.S. dollar. This method, where foreign currency prices are quoted as US$ 1, is known as stating the price in European terms. The prices of some currencies, such as the British pound and Australian dollar, however, are quoted in terms of variable units of U.S. dollars per unit of their currency. Such quotations are known as American terms. Bid and Offer Rates Rates in the foreign exchange market are quoted as bid and offer rates. A bid is the rate at which the bank is willing to buy a particular currency, and an offer is the rate at which it is willing to sell that currency. Banks in the market are generally required by convention and practice to quote their bid and offer prices for particular currencies simultaneously. When quoting their bid and offer rates for a particularly currency, banks quote a price for buying the currency that is lower than the price they charge for selling it. The difference between the buying and selling price is called the bid-offer spread. In a typical spot market transaction a U.S. dollar-pound sterling quote would be 1.8410-1.8420. The quote on the left-hand side would be the bid rate, at which the bank would be willing to sell US$1.8410 in exchange for a pound. The quote on the righthand side would be the offer rate, at which the bank would be willing to buy US$1.8420 for a pound. Notice that the selling rate is higher because the bank is prepared to sell fewer dollars for a pound (US$1.8410) than it is prepared to buy. The use of both American and European terms reverses the bid-offer order. Moreover, a bid quote for one currency is an offer quote for the other currency in the transaction. To avoid confusion, a useful rule of thumb is to remember that in its quote the bank will always part with smaller amounts of the currency it is selling than it will receive when it is buying. In the example, the bank is willing to part with US$1.8410 per unit of pound sterling when selling them, but it wants to receive US$ 1.8420 per unit of pound sterling when it is buying. In practice, exchange traders quote only the last two decimals of the exchange rate, especially in the inter-bank market. The inter-bank quotations of bid-offer rates feature extremely fine spreads because transactions are in huge volumes and the competition is intense. Cross Rates Exchange rates are quoted prices of one currency in terms of another currency. In practice, however, prices of all currencies are not always quoted in terms of all other currencies, which is particularly true of currencies for which there is no active market. For example, rate quotations for Malaysian ringgits in terms of Swedish krona are not easily available, but both currencies are quoted against the U.S. dollar. Their rates with reference to the dollar can be compared, and a rate can be determined between these two currencies.
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Premiums and Discounts The spot price and forward price of a currency are invariably different. When the forward price of the currency is higher than the spot price, the currency is said to be at a premium. The difference between the spot price and forward price in this case is called the forward premium. When the forward rate of a currency is lower than the spot rate, the currency is said to be at a discount. The difference between the spot and forward rate in this case is called the forward discount. Some illustrations of forward premiums and discounts are: Spot rate for U.S. dollar/Can. dollar = Can$1.19 Forward rate for U.S. dollar/Can. dollar = Can$ 1.29. Notice that in the forward rate, it will require Can$1.29 to buy US$1, while in the spot rate only Can$1.19 is required. The U.S. dollar is costlier in the forward quote than in the spot quote and is therefore at a premium against the Canadian dollar. The premium on forward quotes of the U.S. dollar is Can$0.10. Now, assume the following exchange rates between the U.S. dollar and Canadian dollar: Spot rate: Can$1.29 = US$1 Forward rate: Can$1.09 = US$1 In this case the spot rate for the U.S. dollar is more expensive, in terms of Canadian dollars, than the forward rate. In other words, the U.S. dollar is cheaper in the forward market; because only Can$ 1.09 is needed to buy US$ 1 forward, whereas Can$ 1.29 is needed to buy US$ 1 in the spot market. Thus, the U.S. dollar is at a discount of Can$0.20 in the forward market. It is very important to recognize the type of quotation when considering forward premiums and discounts. When the quotes are indirect, that is, when the home currency is expressed as a unit and the foreign currency as variable, forward premiums are subtracted from the spot rate to arrive at the forward rate. Similarly, forward discounts are added to the spot rate to get the forward rate. Following are examples showing premiums and discounts.1 Premium: Spot rate: US$1 = Can$1.29 Forward premium on Can$ = Can$0.010 Forward rate for US$/Can$ = Can$1.28 Discount: Spot rate: US$1 = Can$1.29 Forward discount on Can$ = Can$0.020 Forward rate for US$/Can$ = Can$1.31
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When the exchange rates are quoted as direct rates, that is, when the foreign currency is the unit, premiums are added to the spot rate to arrive at the forward rate; discounts are subtracted. Consider a situation in which the pound sterling is at a premium: Spot rate: 1= US$1.78 Forward premium on = 0.10 Forward rate for 1/US$ = US$1.88 Consider a situation in which pound sterling is at a discount and direct quotations are used. The forward rates will be calculated as follows: Spot: 1= US$1,864 Forward discount: US$0,020 Forward rate: 1 = US$1,844 Notice that the method of arriving at the forward rate is reversed when moving from direct to indirect rates. Remember, however, that the basic rule applicable to all types of quotations is that a currency at a premium will buy more units of the other currency in the forward market than in the spot market, while the reverse will be the case when the currency is at a discount. Also, it is important to note that the premium and discount calculations will be applied at the variable currency, either in a direct or indirect quote. Thus, in the examples above, currencies that are at a premium or discount are the ones that are variable, that is, whose rates are not expressed as a unit. Forward premiums and discounts arise when the exchange markets expect the future value of currencies to be either higher or lower. The amount of premium can and does vary quite often with the length of the forward quote, and banks often quote a series of exchange rates indicating the forward premium or discount over a range of forward deliveries. Table 2 illustrates a typical foreign exchange forward quotation. In this quotation, the 30-day forward quote shows Canadian dollars at a premium of 10 points, while 60-day and 90-day premiums are at 20 and 30 points, respectively. Points here represent values in terms of the fourth decimal place of the exchange rate quotation.
3.8 Exchange Rate

One important factor that distinguishes international trade from domestic trade is the existence of different national currencies. While the goods and services move from one country to another, in settlement of the transaction, money should flow in the reverse direction. An importer in USA, for instance, pays in
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US dollars, which should be received by the Indian exporter in Indian rupees. Foreign exchange market provides the mechanism by which currency of one country is converted into currency of another country. The price at which one currency is exchanged for another currency is known as exchange rate. For instance, if the foreign exchange market in India quotes the rate of US dollar as Rs. 46, it means one dollar is exchanged for Rs. 46. This is the exchange rate for US dollar in terms of Indian rupee. The foreign exchange rate is not static. Similar to the price of a share in the equity market, the value of a currency in the exchange market is also very volatile. There are a number of factors which affect the exchange rate between two currencies. All the transactions in the balance of payments of a currency result in either demand for or supply of foreign exchange. For instance, imports and investments made by residents abroad create demand for foreign exchange. Exports and foreign investments in India supply foreign exchange in the market. Other factors like relative changes in the interest rates in the countries, changes in inflation rates, political and economic developments affect the exchange rates. However, how far these factors are allowed to influence the exchange rate in the market depends on the monetary system adopted by the countries concerned. The country may adopt either (a) fixed exchange rate system, or (b) floating exchange rate system. When the country adopts fixed exchange rate system, the exchange rate of the currency is kept at the desired level by the government concerned. The market forces may not be allowed to influence the exchange rates. The exchange rate, therefore, remains at a pre-determined rate, but for small fluctuations. When the floating rate system is adopted, there is little interference of the government in the exchange rate determined by the market. Exchange rates are allowed to fluctuate freely depending on the market forces. In practice, many countries have adopted exchange rate systems which fall in between the two extremes of fixed and fluctuating rates. Exchange Rate Determination Some of the instruments available in the foreign exchange market like forward exchange contracts, currency swaps, options, etc., help to a great extent in minimizing the foreign exchange risk. This risk could be further minimized if an organization involved in international business has an idea about why exchange rate changes and how it changes. Though there is no one single theory available which explains why/how exchange rate changes, but this is for certain that the exchange rate depends on the demand and supply of a currency. For example, if the demand for British pound is more than its supply, then the British pound will appreciate. On the other hand, if the supply of U.S. dollars is more than its demand then the U.S. dollar will depreciate. The organizations involved in international business are interested in finding out why the demand and supply of a currency changes so that they could predict the future exchange rates. Though there is no clear cut answer of this question, but most of the exchange rate theories admit that there are three
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important factorsthe nations price inflation, interest rate and market psychology, which influence the exchange rate movements. Fixed Exchange Rates Fixed exchange rate refers to a system that permits only very small deviations. Fixed exchange rate refers to maintenance of external value of currency at an officially determined level. In the event of the exchange rate deviating from the official level it will be corrected through official intervention. Official intervention refers to purchase or sale of foreign exchange from/to the market by the central bank of the country with a view to regulate the exchange rate. If there is more demand for foreign currency with the exchange rate tending to appreciation of the foreign currency beyond the limit fixed by the central bank, it will supply foreign currency in the market by drawing from its reserves. If the supply of foreign currency in the market is more and thereby the foreign currency tends to depreciate, the central bank absorbs the excess liquidity by purchasing foreign currency from the market. When International Monetary Fund was instituted, one of its main functions was to specify the par value of every currency in terms of gold and US dollars. This is the officially pre-determined value. The actual market value was allowed to fluctuate around a narrow margin from this level. When Articles of IMF was amended in the year 1978 the par value system was abolished. However some countries continue to fix their currency value in terms of a single major currency or a basket of few currencies. For example, Pakistan and Egypt have pegged their currencies in terms of U.S. dollar and are allowed to vary only within a narrow band. When currency value is fixed in terms of foreign currencies, then we cannot expect the automatic mechanism to correct the balance of payments imbalance through exchange rate changes. For example, when there is balance of payments deficit, currency will not be allowed to depreciate spontaneously as a corrective measure. Hence deliberate devaluation will be done by the Central Bank with a view to reducing imports and increasing exports. On the contrary, revaluation, that is increase in the value of domestic currency in terms of the foreign currency, will be pursued when balance of payments is surplus. This will make domestic exports costlier and imports cheaper and finally will reduce the surplus and imbalance will be corrected. Devaluation or revaluation of the currency will be done by the central bank not frequently. As said earlier, the changes in exchange rates will be endeavoured to be corrected by official intervention. Only when the forces of demand and supply are so powerful as to render intervention ineffective, the country will resort to devaluation or revaluation. Case for Fixed Exchange Rates 1. Provides a check on domestic inflation. Fixed exchange rate system promotes a strict discipline needed in economic policy to prevent a continuing inflation. Policy makers should keep a close watch on domestic inflation rates and if at any time exceeds inflation rate in the world as a whole, contractionary monetary policies should be undertaken to control domestic inflation. Fixed exchange rate virtually
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forces this type of policy action, and failure to do so will lead to an elimination of countrys international reserves. A country with the balance of payments surplus will have to undertake policies in the opposite direction. Of course, the merit of the argument that fixed exchange rate enforces discipline should be qualified. Not always such a discipline is desirable. When countries have other objectives apart from price stability such as higher employment and growth, then contractionary policies may be detrimental. Hence a country facing balance of payments deficit, for example, may not be willing to sacrifice the other goals for the sake of achieving balance of payments balance. 2. Promotes international trade. A long-standing point made by proponents of fixed exchange rate is that they are conducive for the expansion of world trade. Fixed exchange rate is supposed to reduce the level of risk and uncertainty that may arise due to currency price instability. Hence volume of trade will increase; this is true for promoting long-term foreign direct investments. If there is stability in the value of exchange rate one can make a reasonable estimate on the rate of return and in a fixed exchange rate, the return is not subject to currency value fluctuation. 3. Promotes greater efficiency in resource allocation. Another argument put forward in favour of fixed exchange rate is that under fixed exchange rate system when the currency value is stable, there is no incentive for factor movement between the tradable sector and non-tradable sector. If there exist such movement of factors between these sectors, it will only lead to wastage of resources. For example, temporary displacement of labour leads to frictional unemployment. 4. Discretionary policies are more effective. Yet another point in favour of fixed exchange rate system is that fiscal policy is more effective in influencing the level of national income under fixed exchange rate system. For example, under fixed exchange rate system, expansionary fiscal policy where public expenditure is greater than public revenue, balance of payments surplus becomes possible; because increase in the public expenditure rises the interest rate and the rise in the interest rate will bring in capital from other countries. 5. Fixed exchange rate reduces currency speculation. Proponents of fixed exchange rate feel that the incentive for currency speculation will be lesser under this system; hence stability that is essential for trade and investment will be ensured. Floating/Flexible Exchange Rates Free or floating rates refer to the system where the exchange rates are determined by the countrys demand for and supply of foreign exchange hi the market. The rates will vary according to the changes in demand and supply. Unlike freely floating exchange rate, flexible rates of exchange refer to the system where the rate is fixed but is subject to frequent adjustments depending upon the market conditions.
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Crawling Peg
In the system of crawling peg a country specifies a par value for its currency and permits a small variation around the par value such as 2 per cent from parity. Advocates of crawling peg concept point out that, at least in theory, the existence of the ceiling and floor can provide some discipline on the part of monetary authorities. In addition the fact that the rate is periodically changes implies that the role of exchange in balance of payments adjustment is maintained. Managed Floating One another hybrid arrangement of fixed and flexible exchange rates is managed floating. In general managed floating is characterized by some interference with exchange rate movements, but the intervention is discretionary and not automatic on the part of monetary authorities. In other words, there are no announced guidelines or rules for intervention, no parity variation. Inflation Inflation is the situation in which the prices of goods/services rise on account of the fact that the quantity of money in circulation rises faster than the supply of goods and services. It could occur when the increase in supply of money is faster than the increase in supply of goods and services. The concept of inflation in conjunction with the theory of purchasing power parity explains in a better manner how it influences the exchange rates. The purchasing power parity (PPP) theory establishes a relationship between different currencies. The PPP concept compares the prices of the same basket of goods and services in different nations and thus helps in determining the exchange rate between the currencies of the nations involved. For example, suppose an identical basket of goods and services costs Rs. 500 in India and $10 in the U.S.A. Then the exchange rate between Indian rupee and U.S. dollar, as per the PPP theory would be equal to Rs. 500/$I0 or Rs.50 per U.S. dollar (i.e. $1 = Rs.50). Further suppose that the rate of price inflation in India is 5 per cent and in the U.S.A. it is zero per cent. In simple words, it means that the basket of goods and services which costs Rs.500 in India, at the start of year, will cost Rs.525 at the end of the year. On the other hand, the same basket, the cost of which was $10 in the U.S.A. at the start of year, will cost the same at the end of year. Therefore, according to PPP theory, the exchange rate, which was at the start of year Rs.50 per dollar (Rs.500/$10), will become Rs.52.5 per dollar (Rs. 525/$10) i.e. $1 = Rs. 52.5, at the end of year. Thus, because of inflation in India the rupee depreciates against dollar, i.e., one can purchase more units of rupees for the same amount of dollars. To be precise, the percentage depreciation in a currency will be equal to the difference in the inflation rates in the two nations. As in the aforesaid example, the rate of inflation was 5 per cent in India, and zero per cent in the U.S.A. therefore, the Indian rupee depreciates by 5 per cent against the U.S. dollar (difference in inflation rates between India and the U.S.A being 5-0 = 5 per cent).
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The PPP theory for estimating the exchange rates has been used by the news magazine, The Economist, since 1986. The news magazine uses the price of a Big Mac in different nation for finding out the exchange rates and then comparing this with the actual exchange rates in order to determine whether the currency is undervalued or overvalued. The Economist assumes that Big Mac could be used for representing the basket of goods as it is produced in over 120 nations using more or less the same recipe. According to The Economist, the price of Big Mac in the U.S.A. was $2.49 in 2002, and it was Yuan 10.50 in China. So, the implied exchange rate between the two currencies was Yuan 4.22 per dollar (dividing Yuan 10.50 by $2.49), but the actual exchange rate was Yuan 8.28 per dollar. It means that the Yuan was undervalued by 49 per cent against U.S. dollar, in 2002. The main limitation of the Big Mac index lies in the fact that it assumes zero transportation costs and no barrier in trade. The policies followed by the government of a nation, to a great extent, determines the rate of inflation. If the government policies lead to an increase in the money supply, which is faster than the supply of goods and services, then inflation is bound to rise and the currency is likely to depreciate. Normally, when the government of a nation, in order to finance the public expenditure, resorts to the softer option of printing more money, instead of going for the harder option like taxing people, then it will lead to higher inflation rate and depreciation of currency. So, an organization involved in international business can have a fairly good for about the exchange rate movement, i.e., whether the currency of the nation will appreciate or depreciate and to some extent its degree also, by having a look at the policies of the nation Argentina, Bolivia and Brazil, are examples of nations the currencies of which depreciate highly on account of high inflation rates which were the result of the increase in the money supply. Interest Rates Apart from the inflation rates, the interest rates also help in understanding the movement of the exchange rate. Generally, it is seen that the interest rates are high in nations in which the inflation rates are high. The reason that the holder of the currency wants to be compensated for the decline in the value of the currency. To understand the relationship more clearly, one must look at the Fisher Effect theory. According to this theory, the relationship between the nominal interest rate r, the real interest rate R and the inflation rate i, is given as: (1 + r) = (1 + R) (1 +i) The nominal interest rate is the actual monetary return on the investment, whereas the real interest rate is the nominal interest rate minus the inflation rate. In a situation where free movement of capital is allowed the real interest rate will be same throughout. For example, if the real interest rate is 5 per cent in India and it is 8 per cent in China, then investors would borrow money in India and invest in China. This will lead to more demand for money in India and more supply of money in China. The result will be that the real interest rate will rise in India and it will fall in China until the rate becomes same in both the nations. (This situation, however, does not occur in reality on account of the governments involvement and control over capital movement between nations).
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For example, if the real interest rate in India and China is 5 per cent and the inflation rates are 8 and 12 per cent, respectively. Then according to the Fisher Effect theory, the nominal rates in India and China will be calculated as follows: Nominal interest rate in India rI = (1 + (5/100)) (1 + (8/100)) - 1 rI = (1.05) (1.08) - 1 = 1.1340 - 1 = 0.1340 or 13.4 per cent Nominal interest in China will be rc = (1 + (5/100)) (1 + (12/100)) - 1 = (1.05) (1.12) - 1 = 1.1760 - 1 rc = 0.1760 or 17.6 per cent Thus, if the real interest rate is same between the nations, then the difference in nominal interest rates occur due to the difference in the inflation rates. This helps in explaining a very important fact that the nominal interest rate tends to be high in the nations which expect high inflation rates. Another important theory, known as the International Fisher Effect, says that the difference in the interest rates is an unbiased predictor of future exchange rate movements. The change in exchange rate should be proportional to the difference in interest rates, but in opposite direction. For example, if the interest rate in India is 10 per cent and China is 15 per cent, then the Chinese currency Yuan is likely to depreciate by 5 per cent, against Indian rupee, in future. The explanation of exchange rate movement by International Fisher Effect theory is based on the differences in interest rates. These differences in interest rates are due to the differences in inflation rates. The discussion under the purchasing power parity theory explained how inflation rates influence the exchange rates. Thus, keeping the International Fisher Effect theory and the PPP theory in mind, one can predict that, in the long run, the currency of a nation having high interest rate and inflation rate is likely to depreciate. Investor Psychology The empirical evidence suggests that though both the inflation rates and the interest rates are able to explain the changes in the exchange rate movement over a long period of time, but they have failed, in certain situations, to explain the changes in exchange rates over a short period of time. These changes in short-term exchange rate movements could be better explained on the basis of investor psychology. The psychology of an investor is influenced by a number of factors and it is nearly impossible to come out with an exhaustive list of all such factors. One important factor could be the decision taken by an
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individual or an organization, well established in business. For example, when George Soros decided to sell pounds and purchase German marks, in early 1990s, other investors joined him and the ultimate result was depreciation in the value of pound. Sometimes, political events could influence the investor psychology. In 2002, the Brazilian currency, the real, depreciated because of the high poll ratings for a left wing candidate in the run up to presidential election. This made the investors feel that the person will not be able to manage the finances and the result was depreciation in the value of currency. Or if, sometimes, the confidence of the investors shakes, then this could also influence the exchange rate movement. For example, in 1997, the foreign investors lost confidence in the ability of many South Korean firms that they will be able to service their debt payments. The result was that they started withdrawing money from South Korea and the Korean won depreciated by more than 50 per cent. Forecasting Exchange Rate Many experts are of the view that forecasting exchange rate is a sheer wastage of resource like men, money and time. They feel that the forward exchange rates best forecast the future spot rates and as such an organization involved in international business should use them and not get too much concerned about forecasting. However, certain recent studies have shown that the above view does not always hold true. This has provided a fillip to the proponents of future exchange rate forecasting who feel that the forward exchange rates must be supplemented by the predictions of exchange rate forecasting whenever an organization involved in international business takes any decision regarding future investments or revenues. Basically, there are two approaches available for forecasting the exchange ratesthe fundamental analysis approach and the technical analysis approach. In the fundamental analysis approach, a model is developed for forecasting. This model tries to take into account all the possible factors which can influence the exchange rate like the money supply; the inflation rate; the interest rate; the balance of payments position; the foreign exchange reserves position; and the monetary and the fiscal policy. Then, after analyzing these factors carefully, the future exchange rate is predicted. In the technical analysis approach, the exchange rate is forecasted on the basis of the pattern which it has followed in the past. It is assumed in technical analysis that the past trend, cyclical movements and other movements, will continue in the same pattern in future also. Thus, technical analysis tries to provide a value of future exchange rate on the basis of assumption that the conditions which prevailed in the past will also continue in the future. Some economists criticize the technical analysis approach on the grounds that it does not have any logical theoretical base hence; it is as good as fortune telling. One thing which should always be kept in mind is that forecasting is only an educated guess. Therefore, there is always a probability that it could go wrong as far as the timing of exchange rate movement is concerned or its direction is concerned or its magnitude is concerned. But it generally aids and helps in better decision-making regarding future exchange rates.
98 3.10 Review Questions

1. 2. 3. 4. 5.
Explain the Financial Environment of International Business. Explain international financial markets. What is Foreign exchange and explain exchange rate of determination? Explain the various sources of Finance for International Business. Explain the concept of International Finance?
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Module IV REGULATION OF INTERNATIONAL BUSINESS

Institutional Environment of International Business Trade Related Investment Measures (TRIMS) Goals of MNCs Conflict between Multinationals and Government International Business Laws
4.1 Institutional Environment of International Business

Economic system is an organization of institutions established to satisfy human needs/wants. There are three types of economic systems, viz., capitalism, communism and mixed. Economic systems are based on resource allocation in the system. They are market allocation in case of capitalistic, command/ central allocation in case of communistic and mixed allocations in case of mixed economic system. In fact, there are no examples of pure capitalistic or communistic economies. All actual systems are mixed economic systems of varied degrees of market allocations and command allocations. Capitalistic Economic System Under this system, customer allocates resources. Customers choice for product/services decides what
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will be produced by whom. This economic system provides for economic democracy, thus giving the customer, his choice for products/services. This system emphasizes the philosophy of individualism believing in private ownership of production and distribution facilities. The limitation of this economic system made the Governments introduce the welfare state concept which includes: workmens compensation law, provision for social security, labour legislations for state and housing, agriculture, medical, food, transportation, communication, security, education, water, power supply etc. The USA, Japan and the UK are the examples of capitalistic countries. Most of the other countries like India, France, Italy and Malaysia have started shifting their economic systems towards this economic system. Mixed Economic System Under this economic system, major factors of production and distribution are owned, managed and controlled by the state. The purpose is to provide the benefits to the public more or less on equity basis. The other factors of mixed economic system are development of strong public sector, agrarian reforms, control over private wealth, regulation of private investment and national self-reliance. This system does not distribute the existing wealth equally among the people, but advocates the egalitarian principle. It believes in full employment, suitable rewards for the workers efforts. This is also called Fabian socialism. As mentioned earlier, there is no pure capitalistic system or communistic economic system. All capitalistic systems have a command sector and communistic systems have a market sector. The command sector accounts for 32 per cent in the USA, 40 per cent in India and 64 per cent in Sweden. The trend that is taking place in the globe today is the move towards privatization, i.e., move towards market allocation. The UK, France, Holland and India, for example, have reduced their command sector after 1990. Communistic Economic System In this, economic system, private property and property rights to income are abolished. The state owns all the factors of production and distribution. Communism is also called Marxism. Lenin set up a communist state .in Russia after the Great October Revolution of 1917. Later, the ideology spread to Czechoslovakia, China, Rumania, Yugoslavia, Poland and Sweden. Most of the East European countries follow the Marxist ideologies. In communistic/command allocation countries, the resource allocation decisions are made by the government planners. The number of automobiles, shoes, shirts, television sets - their size, colour, quality, features etc., motor cycles, and scooters are determined by government planners. Under this system, consumers are free to spend their income on what is available.
Module IV - Regulation of International Business
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The major limitations of this system include: It reduces individual freedom of choice due to restrictions on items to be produced. IT imposes too many restrictions on MNCs and FDI. It fails to get total commitment of people to work and countrys welfare. It failed to achieve significant economic growth. It could not achieve equality - the main plank of Marxism. The rules of this system did not set fine example for the executors to follow or implement. It has been obsessed with rights of workers.
4.2 Trade Related Investment Measures (TRIMS)

The agreement on Trade Related Investment Measures (TRIMS) requires the investment measures to conform to national treatment and not to impose quantitative restrictions like prescription of minimum local procurement by foreign companies or for imports by companies to be matched by exports. Objective of TRIMS TRIMS will protect the interests of the foreign investors. The capital and the profits will be protected and the investee countries will have the obligation to allow the repatriation of capital and profits. The foreign companies will enjoy the same rights as enjoyed by the local/domestic companies. This is expected to increase the flow of foreign direct investment. More investment is supposed to lead to greater production and more income. Many rights have been given to the foreign investors. This will provide unfettered rights to the big corporation and many developing countries having less income than the companies will not have any control over the companies. When Japan and the South East Asian nations started dominating the global scene in international trade, the United States tried to re-establish its supremacy through trade in services; The United States introduced TRIMS in the eighth around (Uruguay Round) of GATT deliberations, though TRIMS was not there in the original agenda of GATT. The multinational corporations desired to get many concessions from the countries in which they were investing. They wanted that their capita] should be protected and they should enjoy all the privileges extended to the domestic companies by the local governments. The MNCs wanted equal treatment on par with the local companies in the investment countries. Features The salient features of the TRIMS are given below:
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i. ii. iii. iv. v. All restrictions on foreign investments should go.
The foreign investors should be treated on par with the local investors. (iii) There should be no discrimination against the foreign investors. Foreign investors should not be compelled to buy the local materials companies. Foreign investors should not be compelled to export a part of their production There should be no restriction on the repatriation of capital and profit. In the WTO meetings, most developing countries were disappointed and flexed their muscles too, on the discussions on investment. They are worried that TRIMS may not help their economies.
The Adverse Effects the Growing Powers of the TNCs Foreign Direct Investment (FDI) by Transnational Corporations (TNCs) has now superseded the global trade to become the most important mechanism for international economic integration. There are 65,000 TNCs with roughly S.50,000 branches and subsidiaries. The global sales of TNCs are around USD 20,000 billion. Many of these TNCs are bigger than most nations in the world. Fifty biggest TNCs have annual incomes larger than those of 131 nations. The WTO agreement has already resulted in multilateralisation of sovereignty in many areas of domestic policy, thereby reducing the powers of people and national Parliaments. The process of globalization and liberalization though did not benefit the poor people, has resulted in rapid increases in trade and production. The major beneficiaries of this change are the big business houses. Curbing of Competition Curbing of competition, particularly the cross-border variety, and lowering of standards and regulations governing interests of labour, consumer and the environment. Entry and Establishment without Screening WTO provides for better market access, i.e., the right of any foreign investor to freely establish on principles of most favoured nation status. Under the proposed dispute settlement provisions, denial of market access can also be taken up. It means that even if an investor or a type of investment is not acceptable to a country for any reason, its government will not be able to exercise any option. No country can deny entry to a foreign investor except on very few grounds. National treatment without any discrimination would be the cornerstone both before and after the establishment. Exceptions sought under Public Order are being criticized. Any investor can raise a
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dispute on both pre-establishment and post-establishment discrimination. Any reservation/exception should be narrow, clearly defined and transparent. Issues like balance of payments will be allowed, if at all, for a temporary period only. Transfer of Money Investors will have the right to transfer all money accrued due to profits, sale proceeds, proceeds from liquidation, payments for technical and managerial services, royalties from use of trademarks or patents or other such intellectual properties. This unfettered right to transfer all money is given to the investor even if the investee-country does not like it. An unfettered right without any restrictions the investor may have towards the host country, will mean discrimination against domestic enterprises. This may not be in the interest of the investee-countries. Movement of Key Personnel Investors will be allowed free movement of key personnel between one and the other units regardless of nationality. There would be no restrictions or conditions on the nationality of board members. It means that an investor can move personnel from one unit to another as it suits them and would not accept any condition on appointment of board members from the host country. Investor Protection TRIMS provide for strong and effective protection for investors against nationalization and expropriation. This will protect the interests of the investors but the in ves tee-country may not have any control over foreign companies. Under the current globalization and liberalization process, nationalization or expropriation of foreign investors assets is an extreme chance, but if a country decides to nationalize all units in one sector for development policy reasons, e.g., all local and foreign companies are nationalized without any discrimination; there would be a case for foreign investors alone. Dispute Settlement Provisions for both the investor-State and State-State dispute settlement should be there which should also allow international arbitration or appeal to an international tribunal. The provisions on dispute settlement are the most crucial for any agreement as they determine the exact spirit and letter of the agreement, and once a dispute is raised, its settlement will interpret the meaning of the agreement and create case law precedents. The investors can take action against a government in its domestic jurisdiction and vice-versa on the principles of non-discrimination; it would mean that a domestic investor will also have the right to take action against his government in an international forum. This is ridiculous.
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No Code of Conduct for the TNCs
The governments of the investee-countries are controlled by the TRIMS but there is no control on the TNCs. There is no code of conduct for them. No action is prescribed against them but all attempts have been made to protect them. Multilateral trade negotiations introduced TRIPS in the Uruguay Round of GATT. The industrialized North insisted that TRIPS should be included in the final Act. The Agreement on Trade Related Aspects of Intellectual Property Rights provides for the availability and enforcement of such rights. The Agreement establishes minimum standards on the following: i. ii. iii. iv. v. vi. vii. Copyrights and related rights, including computer programmes and data bases; Trademarks; Geographical indications; Industrial designs; Patents; Integrated circuits; and Trade secrets.
This Agreement on TRIPS incorporates the conventions of Paris, Berne, Rome and Washington which provide for the protection of such rights. Article 1.1 calls upon the members to provide for full protection of such rights. The development of detailed provisions on enforcement in the TRIPS agreement is a major departure from the pre-existing conventions on Intellectual Property Rights. The Agreement stipulates specific obligations related to administrative and judicial procedures including provisions on evidence, injunctions, damages, and measures against counterfeiting and penalties in the case of infringement. Any controversy as to compliance with regard to minimum standards should be subject to a multilateral procedure in accordance with the Dispute Settlement Understanding. Once the violation has been established, the affected country can apply cross retaliation to the non-complying country. This mechanism provides for an institutionalized, multilateral means to address disputes relating to IPRs. It is aimed at preventing unilateral actions. The TRIPS (Trade Related Intellectual Property Rights) is certainly an important and controversial issue that adds on considerably to the challenges faced by the Third World countries. The genetic materials of the South in the form of biodiversity and of the traditional seeds or medicinal plants identified and evolved through generations by farmers and forest dwellers are not patentable, and belong to the domain of the common heritage of mankind, to be freely shared, even with the
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developed countries. But the genetically modified seeds, plant life or animal life (mainly in the possession of the developed countries) are to be subject to Intellectual Property protection. The TRIPS draft agreement in the Uruguay Round of GATT made it compulsory for Southern countries to adopt IPR regime with standards similar to the Northern countries, and this would put the South at a serious disadvantage in terms of indigenous technological capacity building. History of Patent Rights Patents, trademarks and other intellectual (industrial) property rights are not natural human rights. Ancient Greece (7th century B.C) granted to cooks a monopoly for one year to exploit new recipes. But a few centuries later, Emperor Zeno in Rome (480 AD) rejected the concept of monopoly. The city state of Venice, the first to establish a patent Jaw in 1474, granted the rights on condition that the patent is worked; otherwise the patent rights were forfeited. The 1791 French patent law said that the monopoly of the inventor was a Natural right. Not so, said Austria in 1794. It called patents an exception to the natural right of citizens to have access to inventions.2 There is no definition of patent in 1883 Paris convention. In the joint study by the UNO, UNCTAD and WIPO, the International Bureau of the WIPO provided a description of the patent, as a legally enforceable right granted by virtue of law to a person to exclude, for a limited time, others from certain acts in relation to a described inventions; the privilege is granted by a government authority as a matter of right to the person who is entitled to apply for it and who fulfils the prescribed conditions. Thus the patent rights are privileges granted by the State to reward inventive work of individuals. Reasons for the Emergence of IPR Regime Technology became a major issue in development since 1970. The rate of technological progress was rapid in 1970s, 1980s, 1990s and later. It had no parallel in history. Information technology simplified and solved many issues, problems and concerns of human kind. Computer programmes were evolved to solve the administrative, healthcare, industrial, transport problems apart from taking up the center space in the academic arena. Internet was thrown open to the public in the early 1990s. Mobile phones revolutionized the communication modes. Satellite TV brought entertainment and global news to the drawing rooms. Banking has been completely modified with the emergence of ATMs and anywhere banking. Currencies are sought to be replaced by credit cards and debit cards. E-commerce is increasing its role. Paperless office will be the reality soon. Air travel has become cheaper and more frequent. Global distances have shrunk. Sending a letter from Chennai to New York and getting back the reply through Internet have become cheaper than the cost of a post card. Hollywood films have become more popular. Almost all these developments had their roots in the inventions and discoveries from the laboratories and R & D centers of the developed countries. The developed countries wanted to protect their products, discoveries and inventions. They demanded that a powerful intellectual property regime should be established to protect their rights.
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The Governments of the First World have invested heavily in the research projects and the benefits are being passed on to the private sector. The multinationals had developed new products and services. The developed countries in general and the multinationals in particular, were aggressive in promoting their interests and their products. The multinational/transnational companies wanted to acquire and retain monopoly powers and control over the new products and services. The new products and services also commanded high prices and brought in huge profits.
4.3 Goals of MNCs

The fundamental objective of an MNC is to earn profit and this might clash with the host governments objective of achieving better quality of life for its citizens. Such conflicts need to be resolved by the MNCs using their own initiative. Following are the Goals of MNCs, and their subsidiaries: Manufacture in those countries where it finds the greatest competitive Advantage Buy and sell anywhere in the world to take advantage of the most favorable price to the company. Take advantage, throughout the world, of changes in labour costs, Productivity, trade agreements and currency fluctuations. Expand or contract, based on worldwide competitive advantages Obtain a high and rising return on invested capital. Achieve greater sales. Hold risks within reasonable limits in relation to profits. Maintain and improve technological and oilier company strengths. Maintain control of important decisions. Encounter fewer barriers in host countries.
Fundamental Goals of Host Governments Individual countries have different goals they wish to achieve. Their differences are wider than variations of goals of individual MNCs. However, most countries, developed and less developed, want to
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Achieve economic growth To achieve full employment of people and resources. Improve managerial and worker skills. Maintain price stability. Develop a favorable balance of trade. Achieve a more equitable distribution of income among the population. Retain a fair share of profits made by MNCs in their country. Improve technological development. Improve worker productivity. Increase local ownership of the means of production. Retain hegemony over the economic system. Control national security decisions. Develop and maintain social and political stability. Advance the quality of life of its people. Protect the nations physical environment.
Defenders and Critics of MNCs MNCs are criticized, particularly by developing countries, on grounds like low wages, exploitation of labour, depletion of resources and abuse of human rights. A few grey areas of globalization were brought out in the previous chapter. Criticisms of globalization are also comments on MNCs as the latter are the manifestations of globalization. Nevertheless, we prefer to focus on the grey areas of MNCs separately, as we believe that the multinational companies are the actors, the complete stage being the globalization. The stage comprises the director, artists, technicians, supporting staff and the script. It may be recollected that the MNCs main objective is to earn money. They are operating in any country and in any form to earn profit and not to indulge in philanthropic activities. It may also be stated that the MNCs are not the only entities mat indulge in activities unacceptable to the developing countries. Many of the domestic businesses in the respective developing countries may engage in much more harmful practices. Why, then, are MNCs singled out? It is because of their clout, the resources they command, the deep pockets they carry and the high visibility they exhibit.
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Disadvantages Faced by MNCs Business Risks
MNCs have to bear several serious risks that are not borne by companies whose operations are purely domestic in nature. Since MNCs conduct business outside the borders of their own countries, they deal with the currencies of other countries, which render them vulnerable to fluctuations in exchange rates. Violent movements in exchange rates can wipe out the entire profit of a particular business activity. Over the long run, MNCs often have to live with this risk because it is extremely difficult to eliminate it. Over the short run, however, there are market mechanisms such as currency swaps and forward contracts that allow an MNC to minimize the movement of exchange rates for a particular business transaction. Companies that engage in these forms of financial contracts understand that they are not in the currencyrisk business and that it makes sense to minimize this risk when at all possible. Host-Country Regulations Operating in different countries subjects MNCs to a myriad of host-country regulations that vary from country to country and, in most cases, are quite different from those of the home country. The MNC has the difficult task of familiarizing itself with these regulations and modifying its operations to ensure that it does not overstep them. Regulations are often changed, and such changes can have adverse implications for MNCs. For example, a country may ban the import of a certain raw material or restrict the availability of bank credit. Such constraints can have serious effects on an MNCs production levels. In many developing countries, national controls are quite pervasive and almost every facet of private business activity is subject to government approval. The MNCs of developed countries are not used to such controls, and their methods of doing business are not geared to work in this type of environment. Different Legal Systems MNCs must operate under the different legal systems of different countries. In some countries the legislative and judicial processes are extremely cumbersome and contain many nuances that are not easily understood by non-natives. Some legislation can also prohibit the type of business activity the MNC would regard as normal in its home country. Political Risks Host countries are sovereign entities and their actions normally do not admit any appeals. There is little that an MNC can do if a host country is determined to take actions that are inimical to its interests. This political risk, as it is known, increases in countries whose governments are unstable and tends to change frequently.
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Operational Difficulties Multinationals operates in a wide variety of business environments, which creates substantial operational difficulties. Unwritten business practices and market conventions often prevail in host countries. MNCs that lack familiarity with such conventions find it difficult to conduct business in accordance with them. Often the normal methods of operation of an MNC can be quite contrary to a countrys business practices. A typical example is informal credit. In many countries retailers agree to stock goods of a manufacturing company only if they are offered a market-determined period of credit 15 that is not covered by a written document. The accounting and sales policies of an MNC may not permit such arrangements. On the other hand, performance of business in that country may not be at all possible without such arrangements. The multinational must therefore adjust its business practices or lose business entirely. Cultural Differences Cultural differences often lead to major problems for MNCs. Many find that their expatriate executives are not able to turn in optimal performances because they are not able to adjust to the local culture, both personally as well as professionally. On the other hand, local managers of MNCs often have difficulties in dealing with the home office of an MNC because of culturally based communication problems. Inability to understand and respond appropriately to focal cultures has often led MNC products to fail. Misunderstanding of local cultures, work ethics, and social norms often leads to problems between MNCs and their local customers, their business associates, government officials, and even their own employees.
4.4 Conflict between Multinationals and Government

Every Government supports the development of Multinationals in their country because it gives revenue as well as employment opportunities in the country. Multinationals also supports the Government of every country where they are having their operation to a maximum level since it requires the co-operation of the Government to run their business in a particular country. Multinationals also gets the support of the various political parties and also their influences to run the business in a particular country. Government though imposes several restrictions over the multinationals it gives freedom and support in various aspects of the operation of the multinational companies throughout the world. For Example, in India, the Government provides many tax concessions and subsidies for the multinational company to carry out their activities. The Indian Government provides a good infrastructure to facilitate the easy operation of the multinational companies. The recently opened multinational companies such as IBM, Nokia, and Hyundai etc are getting many concessions from the Indian Government. The Government supports the multinationals in all dimensions. The policy of the Government should support and encourage the multinational companies to remain in
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the country. The various environments such as political environment, financial environment, technological environment, socio cultural environment should be favorable for the multinationals to continue their operation in any country. Multinational companies expect the cooperation from the Government for their better operation. Main Features of Relationship between Government and Multinationals 1. 2. 3. 4. 5. The economic relationship between the Government and Multinational companies should be strong for the existence of multinational companies Government should cooperate in all dimensions for the successful operation of the multinational companies Regulations and Restriction of the Government should not hinder the development of multinational companies The fiscal policy of the Government should motivate the multinational companies Growth of multinational companies gives more contribution to the economic growth of the country and it gives immense employment opportunities to the people of the country
Conflict between Multinational and Government It is not possible in all cases that there exist cooperation between the Government and the multinational companies. In certain cases, there arise few conflicts which can be resolved by bilateral agreement. Conflicts arise due to various aspects which can be discussed in this chapter later. Often the new economic and financial policies implemented by the Government will conflict the operation of the Multinational companies which is to be considered as the main problem in International Business. The relationship between the Government and multinational companies can be strengthened by mutual understanding and settlement of the disputes. The Government conflicts with the multinational companies for a number of reasons. Change of political parties and change of Government very often creates the conflict between the Government and Multinational companies in International Business. Reasons for the conflict between Government and MNC are as follows 1. 2. 3. New Rules and Regulations implemented by the Government affecting the operation of MNC Change of Government, the change of political environment can create conflict between the Government and Multinational companies which will affect International business New economic policy of the Government may create conflict between MNC and the Government
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4. 5.
Changes in legal framework of a country may also create conflict with the Government and Multinational companies Any change in the industrial policy of the Government may conflict with the multinational companies
The above given reasons may create conflicts between the Government and the multinational companies and resolution of such conflicts will be remedy for the existence of multinational companies. The various sources of conflict which arises between the Government and Multinational companies should be analyzed and the required solutions should be implemented for strengthening the relationship between the Government and multinational companies. International business has its base on the cooperation given by the various Governments. Conflicts between the Government and multinational companies acts as the important barrier for the development of International Business. Conflict between the Government and multinational companies affects the International Trade between various nations. As the result of Globalization and liberalization of economic policy, there should be cooperation between the Government and multinational companies. Conflict in various areas should be analyzed and can be resolved by mutual agreements. Conflicts creates unhealthy atmosphere for the development of International business. Conflicts arising in various functional areas can be resolved by the formulation and implementation appropriate amendments. Regulations in International Business Traditionally trade was regulated through bilateral treaties between two nations. For centuries under the belief in Mercantilism most nations had high tariffs and many restrictions on international trade. In the 19th century, especially in the United Kingdom, a belief in free trade became paramount. This belief became the dominant thinking among western nations since then. In the years since the Second World War, controversial multilateral treaties like the General Agreement on Tariffs and Trade (GATT) and World Trade Organization have attempted to create a globally regulated trade structure. These trade agreements have often resulted in protest and discontent with claims of unfair trade that is not mutually beneficial. Free trade is usually most strongly supported by the most economically powerful nations, though they often engage in selective protectionism for those industries which are strategically important such as the protective tariffs applied to agriculture by the United States and Europe. The Netherlands and the United Kingdom were both strong advocates of free trade when they were economically dominant, today the United States, the United Kingdom, Australia and Japan are its greatest proponents. However, many other countries (such as India, China and Russia) are increasingly becoming advocates of free trade as they become more economically powerful themselves. As tariff levels fall there is also an increasing willingness to negotiate non tariff measures, including foreign direct investment, procurement
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and trade facilitation. The latter looks at the transaction cost associated with meeting trade and customs procedures. Traditionally agricultural interests are usually in favour of free trade while manufacturing sectors often support protectionism. This has changed somewhat in recent years, however. In fact, agricultural lobbies, particularly in the United States, Europe and Japan, are chiefly responsible for particular rules in the major international trade treaties which allow for more protectionist measures in agriculture than for most other goods and services. During recessions there is often strong domestic pressure to increase tariffs to protect domestic industries. This occurred around the world during the Great Depression. Many economists have attempted to portray tariffs as the underlining reason behind the collapse in world trade that many believe seriously deepened the depression. The regulation of international business is done through the World Trade Organization at the global level, and through several other regional arrangements such as MERCOSUR in South America, the North American Free Trade Agreement (NAFTA) between the United States, Canada and Mexico, and the European Union between 27 independent states. The 2005 Buenos Aires talks on the planned establishment of the Free Trade Area of the Americas (FTAA) failed largely because of opposition from the populations of Latin American nations. Similar agreements such as the Multilateral Agreement on Investment (MAI) have also failed in recent years. Foreign Exchange Regulation Act, 1973 The Foreign Exchange Regulation Act of 1973 (FERA) in India was repealed on 1 June, 2000. It was replaced by the Foreign Exchange Management Act (FEMA), which was passed in the winter session of Parliament in 1999. Enacted in 1973, in the backdrop of acute shortage of Foreign Exchange in the country, FERA had a controversial 27 year stint during which many bosses of the Indian Corporate world found themselves at the mercy of the Enforcement Directorate (E.D.). Any offense under FERA was a criminal offense liable to imprisonment, whereas FEMA seeks to make offenses relating to foreign exchange civil offenses. FEMA, which has replaced FERA, had become the need of the hour since FERA had become incompatible with the pro-liberalization policies of the Government of India. FEMA has brought a new management regime of Foreign Exchange consistent with the emerging frame work of the World Trade Organization (WTO). It is another matter that enactment of FEMA also brought with it Prevention of Money Laundering Act, 2002 which came into effect recently from 1 July, 2005 and the heat of which is yet to be felt as Enforcement Directorate would be investigating the cases under PMLA too. Unlike other laws where everything is permitted unless specifically prohibited, under FERA nothing was permitted unless specifically permitted. Hence the tenor and tone of the Act was very drastic. It provided for imprisonment of even a very minor offence. Under FERA, a person was presumed guilty
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unless he proved himself innocent whereas under other laws, a person is presumed innocent unless he is proven guilty. Objectives and Extent of FEMA The objective of the Act is to consolidate and amend the law relating to foreign exchange with the objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India. FEMA extends to the whole of India. It applies to all branches, offices and agencies outside India owned or controlled by a person who is a resident of India and also to any contravention there under committed outside India by any person to whom this Act applies. Except with the general or special permission of the Reserve Bank of India, no person can: deal in or transfer any foreign exchange or foreign security to any person not being an authorized person; make any payment to or for the credit of any person resident outside India in any manner; receive otherwise through an authorized person, any payment by order or on behalf of any person resident outside India in any manner; reasonable restrictions for current account transactions as may be prescribed.
Any person may sell or draw foreign exchange to or from an authorized person for a capital account transaction. The Reserve Bank may, in consultation with the Central Government, specify: any class or classes of capital account transactions which are permissible; the limit up to which foreign exchange shall be admissible for such transactions
However, the Reserve Bank cannot impose any restriction on the drawing of foreign exchange for payments due on account of amortization of loans or for depreciation of direct investments in the ordinary course of business. The Reserve Bank can, by regulations, prohibit, restrict or regulate the following: transfer or issue of any foreign security by a person resident in India; transfer or issue of any security by a person resident outside India; transfer or issue of any security or foreign security by any branch, office or agency in India of a person resident outside India; any borrowing or lending in foreign exchange in whatever form or by whatever name called;
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any borrowing or tending in rupees in whatever form or by whatever name called between a person resident in India and a person resident outside India; deposits between persons resident in India and persons resident outside India; export, import or holding of currency or currency notes; transfer of immovable property outside India, other than a lease not exceeding five years, by a person resident in India; acquisition or transfer of immovable property in India, other than a lease not exceeding five years, by a person resident outside India; giving of a guarantee or surety in respect of any debt, obligation or other liability incurred (i) by a person resident in India and owed to a person resident outside India or
(ii) by a person resident outside India. A person, resident in India may hold, own, transfer or invest in foreign currency, foreign security or any immovable property situated outside India if such currency, security or property was acquired, held or owned by such person when he was resident outside India or inherited from a person who was resident outside India. A person resident outside India may hold, own, transfer or invest in Indian currency, security or any immovable property situated in India if such currency, security or property was acquired, held or owned by such person when he was resident in India or inherited from a person who was resident in India. The Reserve Bank may, by regulation, prohibit, restrict, or regulate establishment in India of a branch, office or other place of business by a person resident outside India, for carrying on any activity relating to such branch, office or other place of business. Every exporter of goods and services must: Furnish to the Reserve Bank or to such other authority a declaration in such form and in such manner as may be specified, containing true and correct material particulars, including the amount representing the full export value or, if the full export value of the goods is not ascertainable at the time of export, the value which the exporter, having regard to the prevailing market conditions, expects to receive on the sale of the goods in a market outside India; Furnish to the Reserve Bank such other information as may be required by the Reserve Bank for the purpose of ensuring the realization of the export proceeds by such exporter.
The Reserve Bank may, for the purpose of ensuring that the full export value of the goods or such reduced value of the goods as the Reserve Bank determines, having regard to the prevailing marketconditions, is received without any delay, direct any exporter to comply with such requirements as it deems fit.
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Where any amount of foreign exchange is due or has accrued to any person resident in India, such person shall take all reasonable steps to realize and repatriate to India such foreign exchange within such period and in such manner as may be specified by the Reserve Bank. Section 3: Except as provided in the FEMA Act, rules and RBI permission, no person shall: Deal in/ transfer any forex to any person not being an authorized person Make any payment to or for the credit of any nonresident Receive otherwise through an authorized person, any payment by order or on behalf of any nonresident Enter into any financial transaction in India as consideration for or in association with acquisition or creation or transfer of a right to acquire, any asset outside India by any person Contraventions and Penalties If any person contravenes any provision of this Act, or contravenes any rule, regulation, notification, direction or order issued in exercise of the powers under this Act, or contravenes any condition subject to which an authorization is issued by the Reserve Bank, he shall, upon adjudication, be liable to a penalty up to thrice the sum involved in such contravention where such amount is quantifiable, or up to two lakh rupees where the amount is not quantifiable, and where such contravention is a continuing one, further penalty which may extend to five thousand rupees for every day after the first day during which the contravention continues. Any Adjudicating Authority adjudging any contravention may, if he thinks fit in addition to any penalty which he may impose for such contravention direct that any currency, security or any other money or property in respect of which the contravention has taken place shall be confiscated to the Central Government and further direct that the foreign exchange holdings, if any, of the persons committing the contraventions or any part thereof, shall be brought back into India or shall be retained outside India in accordance with the directions made in this behalf. Property in respect of which contravention has taken place, shall include deposits in a bank, where the said property is converted into such deposits, Indian currency, where the said property is converted into that currency; and any other property which has resulted out of the conversion of that property. If any person fails to make full payment of the penalty imposed on him within a period of ninety days from the date on which the notice for payment of such penalty is served on him, he shall be liable to civil imprisonment. Investigation The Directorate of Enforcement investigates to prevent leakage of foreign exchange which generally occurs through the following malpractices: Remittances of Indians abroad otherwise than through normal banking channels, i.e. through compensatory payments.
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Acquisition of foreign currency illegally by person in India. Non-repatriation of the proceeds of the exported goods. Unauthorized maintenance of accounts in foreign countries. Under-invoicing of exports and over-invoicing of imports and any other type of invoice manipulation. Siphoning off of foreign exchange against fictitious and bogus imports. Illegal acquisition of foreign exchange through Hawala. Secreting of commission abroad.
Organizational Set Up and Functions of Enforcement Directorate Directorate of Enforcement has to detect cases of violation and also perform substantially adjudicatory functions to curb above malpractices. The Enforcement Directorate, with its Headquarters at New Delhi has seven zonal offices at Bombay, Calcutta, Delhi, Jalandhar, Madras, Ahmedabad and Bangalore. The zonal offices are headed by the Deputy Directors. The Directorate has nine sub-zonal offices at Agra, Srinagar, Jaipur, Varanasi, Trivandrum, Calicut, Hyderabad, Guwahati and Goa, which are headed by the Assistant Directors. The Directorate has also a Unit at Madurai, which is headed by a Chief Enforcement Officer. Besides, there are three Special Directors of Enforcement and one Additional Director of Enforcement. The main functions of the Directorate are as under: To collect and develop intelligence relating to violation of the provisions of Foreign Exchange Regulation Act and while working out the same, depending upon the circumstances of the case: To conduct searches of suspected persons, conveyances and premises for seizing incriminating materials (including Indian and foreign currencies involved) and/or. To enquire into and investigate suspected violations of provisions of the Foreign Exchange Management Act. To adjudicate cases of violations of Foreign Exchange Management Act for levying penalties departmentally and also for confiscating the amounts involved in contraventions; To realize the penalties imposed in departmental adjudication.
Procedural Provisions For enforcing the provisions of various sections of FEMA, 1999, the officers of Enforcement Directorate of the level of Assistant Director and above will have to undertake the following functions.
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Collection and development of intelligence/information. Keeping surveillance over suspects. Searches of persons/vehicles by provisions of Income-tax Act, 1961. Searches of premises as per provisions of Income-tax Act, 1961. Summoning of persons for giving evidence and producing of documents as per provisions of Income-tax Act, 1961. Power to examine persons as per provisions of Income-tax Act, 1961. Power to call for any information/document as per provisions of Income-tax Act, 1961. Power to seize documents etc. as per provisions of Income-tax Act, 1961. Custody of documents as per Income-tax Act, 1961. Adjudication and appeals - Officers of and above the rank of Deputy Director of Enforcement, are cases of contravention of the provisions of the Act; these proceedings which are quasijudicial in nature, start with the issuance of show cause notice; in the event of cause shown by the Notice-not being found satisfactory, further proceedings are held, vis. personal hearing, in which the notice has a further right to present his defense, either in person or through any authorized representative; on conclusion of these proceedings, the adjudicating authority has to examine and consider the evidence on record, in its entirety and in case the charges not being found proved, the notice is acquitted, and in the event of charges being found substantiated, such penalty, as is considered appropriate as per provisions of section 13 of the Act can be imposed, besides confiscation of amounts involved in these contraventions.
Risk in International Business Companies doing business across international borders face many of the same risks as would normally be evident in strictly domestic transactions. For example, Buyer insolvency (purchaser cannot pay); Non-acceptance (buyer rejects goods as different from the agreed upon specifications); Credit risk (allowing the buyer to take possession of goods prior to payment); Regulatory risk (e.g., a change in rules that prevents the transaction); Intervention (governmental action to prevent a transaction being completed); Political risk (change in leadership interfering with transactions or prices);
118 4.5 International Business Laws
International trade law should be distinguished from the broader field of international economic law. The latter could be said to encompass not only WTO law, but also law governing the international monetary system and currency regulation, as well as the law of international development. The body of rules for transnational trade in the 21st century derives from medieval commercial laws called the lex mercatoria and lex maritima respectively, the law for merchants on land and the law for merchants on sea. Modern trade law (extending beyond bilateral treaties) began shortly after the Second World War, with the negotiation of a multilateral treaty to deal with trade in goods: the General Agreement on Tariffs and Trade (GATT). International trade law is based on theories of economic liberalism developed in Europe and later the United States from the 18th century onwards. World Trade Organization In 1995, the World Trade Organization, a formal international organization to regulate trade, was established. It is the most important development in the history of international trade law. The purposes and structure of the organization is governed by the agreement establishing the World Trade Organization, also known as the Marrakesh Agreement. It does not specify the actual rules that govern international trade in specific areas. These are found in separate treaties. Trade in goods The GATT has been the backbone of international trade law throughout most of the twentieth century. It contains rules relating to unfair trading practices dumping and subsidies. Trade and Human Rights The World Trade Organization Trade Related Intellectual Property Rights (TRIPS) agreement required signatory nations to raise intellectual property rights (also known as intellectual monopoly privileges. This arguably has had a negative impact on access to essential medicines in some nations.
Dispute Settlement
Since there are no international governing judges (2004) the means of dispute resolution is determined by jurisdiction. Each individual country hears cases that are brought before them. Governments choose to be party to a dispute. And private citizens determine jurisdiction by the Forum Clause in their contract. Besides forum, another factor in international disputes is the rate of exchange. With currency fluctuation ascending and descending over years, a lack of Commerce Clause can jeopardize trade between parties when one party becomes unjustly enriched through natural market fluctuations. By listing the
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rate of exchange expected over the contract life, parties can provide for changes in the market through reassessment of contract or division of exchange rate fluctuations. International Trade Negotiations Negotiations lie at the heart of international diplomacy. Parties (governments, businesses, and nongovernmental organizations) employ the art and science of negotiation to protect and advance their organizational and constituent interests. The skillful use of negotiation can advance a partys interests and help to avoid a less attractive alternative, e.g., trade wars, litigation, or protracted dispute settlement procedures under the WTO. An effective negotiation process can lead to positive outcomes that can result in the promotion of important international objectives including economic development, business interests, environmental protection, labor rights, and political stability, all of which can minimize the adverse impacts of poverty that can lead to violence and war. Even for students and practitioners who may not aspire to the role of negotiator in the heavy stakes arenas of international negotiation, most professionals negotiate frequently in the performance of their jobs. Whether negotiating for a raise, a vacation, or a promotion with a supervisor or negotiating with peers and subordinates over work assignments, deadlines, or workplace conflicts, we all negotiate all the time. No training manual can guarantee success in any particular negotiating setting, but everyone can improve their negotiating skills to increase the probability of successful outcomes. A first step in approaching the improvement of your own negotiating technique is to develop an awareness or mindfulness of when you are engaged in a negotiation of small or large consequence. Many people undercut their own self-interest by not paying attention to their own role and participation in day to day negotiating scenarios. Depending on the subject matter of a negotiation, different skills must be employed and options exercised to achieve agreement between or among parties. International negotiations in the broad context of trade relations may include negotiations over prices, tariffs, and sales or qualitative negotiations over broad principles related to the environmental, labor, health & safety, or other impacts of trade related agreements. The purpose of this manual is to provide the reader and practitioner with the following analytical and practical skills: Problem identification and development of negotiation goals and strategies Identification of parties (stakeholders) and their respective interests and priorities Development of multiple options (solutions) that will maximize the probability of positive outcomes for all parties to the process
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Development of specific skills in the following areas: Negotiation strategy Pre-negotiation research and planning Negotiation skills and technique to be employed throughout the negotiation process Crafting and drafting durable agreements with an emphasis on successful implementation of the agreement
This manual includes various examples and simulations designed to assist the student and practitioner in how to adapt the theory of principled negotiation to effective practice and success in the negotiation process. While the focus of this manual revolves around trade-related negotiations in the international arena, the applications of these analytical and skills sets may assist those engaged in a multitude of different negotiation scenarios. It is the strong belief of the authors that practice is at the core of an effective negotiation technique. We believe that the use of simulation exercises can be of great benefit to the student of international negotiation. As in the practice of any discipline in politics, art, or sports, the most successful players are those who have learned from repetition of methodical practice. One can gain only a certain level of understanding by acquiring a theoretical knowledge of any discipline. The true practitioner perfects his/her skill and expertise through the repetitive drilling that gives meaning to the axiom that practice makes perfect. We share this manual with all interested students and practitioners with the confidence that through the development and practice of the art and science of interest-based negotiations, the world can be made a better, healthier, and safer place to live. We welcome your comments and feedback, stories of your successes and failures alike. By developing a repository of information we expect that this manual will benefit from revisions, refinements, and the collective inputs of those in the growing community of international negotiators. The Role and Development of Negotiations in Commercial Diplomacy before exploring the other elements of interest-based negotiations, it is essential to describe the range of negotiations that occur in the international and trade arenas. There are profound differences in the subject matter negotiated in international trade and investment in the character of the negotiations, as well as in the level and formality of various levels of negotiations. These differences have important implications for the optimal choice of negotiating strategies. Most international transactions that involve trade and investment are negotiated between private parties: between buyer and seller, importer and exporter, employer and employee, contractor and subcontractor. This addresses the negotiation of policy measures that affect international trade and investment. The
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negotiation of trade-related policy issues primarily centers on the reconciliation of trade-based economic objectives and broader public policy objectives such as health, safety, and the social welfare of disadvantaged groups in society. These different interests of society are reconciled through a complex negotiating process that takes place within and between domestic stakeholder groups such as businesses, unions, civic groups and government agencies, and ultimately between national governments. The special character of commercial diplomacy is that it encompasses both private stakeholders and governments, that it addresses both private commercial interests and public policy interests, and that the outcome is arbitrated through both economic markets and political markets. Negotiations in commercial diplomacy cover business issues, policy issues, broad economic issues and political issues, as well as legal issues. Negotiations in commercial diplomacy potentially involve a wide range of stakeholders the groups who represent the commercial interests, policy interests, political interests, economic interests, legal interests and institutional/bureaucratic interests affected by trade and investment policy decisions. Each of these groups seeks to influence the policy outcome through negotiations. The most visible negotiations carried out in the trade policy arena are the negotiations carried out between governments, either bilaterally or multilaterally. Such government to government negotiations, however, are preceded by intense negotiations within the individual countries on the countrys negotiating position. These internal negotiations often start within the individual firms, industry associations, government agencies, legislative committees, and non-governmental organizations that have a stake, and are followed by the negotiation and formation of policy oriented coalitions among stakeholders for the purpose of influencing the policy outcome. The negotiations to form these coalitions can cross national borders, and involve business leaders, academics, politicians, bureaucrats, and leaders of civil society from many different countries. Coalitions that cross national borders seek to influence the respective governments in parallel. Private stakeholders, whether acting on their own or as representatives of a coalition, negotiate with the various government agencies and politicians involved in the decision making process and ultimately these government agencies and politicians negotiate with each other to arrive at a negotiating position for their country. Often these internal negotiations are much tougher and take a lot more time than the more visible government to government negotiations. Each of the stakeholder groups involved in the trade policy advocacy, decision-making and negotiating process brings their own motivations and interests to bear on the negotiations. As we shall explore more fully later, these interests and motivations are the key to a structured approach to negotiations that has the highest prospects for a satisfactory outcome. The interests and motivations that influence the positions of many stakeholders in the private sector are fairly straightforward, and not too difficult to analyze. The interests and motivations of governments are often much more difficult to identify because governments represent all the various interests of society. Nevertheless, there is a great deal of consistency across governments with respect to the principal interests represented by government agencies and departments responsible for particular areas of government policy. The successful negotiator will prepare him or her by carefully analyzing the interests and political influence of each of the principal stakeholder groups. Most negotiations in commercial diplomacy are over the impact of specific policy measures on particular
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products or industries. The negotiation of such trade or investment related policy issues typically start as a negotiation between an affected enterprise or industry and the government responsible for the targeted policy measure. If the issue is not resolved at that level, the home government of the affected enterprise or industry may step into the dispute by initiating government to government negotiations. These kinds of negotiations usually go through a number of different phases that call for different negotiating attitudes and tactics. The first contact is usually best approached as an informal information gathering effort. After all, the enterprise managers may be ill informed about the specific regulations or laws at issue, or the administrative guidelines followed by the responsible officials. Conversely, the officials involved may be ill informed about the production methods or business practices covered by the regulations. Once the facts have been clarified, and a policy issue has been identified, the negotiation should move into a problem-solving phase. A problem-solving approach, which suspends value judgments about who is right or wrong, encourages flexibility by the negotiating partners, maximizing the chances that an amicable resolution can be found that simultaneously preserves the policy objectives of the government and the commercial objectives of the enterprises involved in the negotiation. The best tactics to use in this type of a win-win negotiation will be explored later. Of course, some policy issues raised by exporters or investors are without merit, while other policy actions taken by governments are not very defensible. In these situations, sometimes the best resolution is a graceful withdrawal before issues of face and prestige make such a withdrawal difficult. If efforts to resolve the issue through a problem solving approach fail, the negotiations may move into a third, more formal stage of negotiation, during which the negotiators may increase the political and legal pressure on the other side. There is an increased risk at this stage that the negotiation may turn into a zero sum game type of negotiation, in which one side or the other has to lose in order to secure a resolution of the issue. As we shall see later, zero sum type of negotiations are more difficult to conclude, and a successful negotiator will keep emphasizing the potential for a win-win outcome. A negotiation that remains deadlocked may be referred to a dispute settlement process. Many trade and investment agreements identify a process for settling disputes that cannot be resolved through negotiations. Some forms of dispute settlement, such as arbitration and mediation, are a structured and assisted form of negotiation. While most day-to-day negotiations between governments on international commercial issues focus on specific commercial problems created by specific policy measures, the negotiations that get the most attention are comprehensive government to government negotiations that cover a wide range of products and policy issues. Examples are bilateral free trade negotiations aimed at removing most barriers to trade and investment between countries, or the multilateral rounds of trade negotiations carried out under the auspices of the world trade negotiations. These negotiations typically address both the reduction and elimination of a wide range of trade barriers and the negotiation of trade rules. These negotiations by their very character have to be approached as win-win negotiations, because no deal is possible
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without each party agreeing that the proposed agreement is in its interest. Rules-based negotiations, in particular, have to start from the identification of common interests that might be advanced through the adoption of the rule. Another type of negotiation in commercial diplomacy is one in which one government seeks to eliminate, or at a minimum to moderate, a restrictive trade policy action by another government. On its face, this kind of negotiation is set up as a zero sum game type of negotiation, and it takes extraordinary skill to convert it into a win-win negotiation. Assuming that the proposed measure has some degree of merit in light of the economic circumstances faced by the country involved, the trick is to show that negotiations can lead to a more balanced consideration of the interests of all parties involved. Another type of negotiation might be one between a stakeholder left out of an agreement and the parties to a negotiated agreement. The aggrieved stakeholder could be a country adversely affected by a bilateral agreement between two other countries, or a non-governmental organization that believes its policy interests have not been adequately considered by the government and business representatives that worked out the deal. Commercial diplomats representing parties not invited to the negotiating table need to consider what tactics might get them invited to the table. Ultimately, this means, that they need to consider how they might identify and mobilize potential allies with the necessary political influence. Each of the various types of negotiations calls for a different negotiating style, and different negotiating skills. Negotiations aimed at defining common interests whether that involves the negotiation of a coalition, the negotiation of a common course of action or the negotiation of common principles or rules, requires a soft sales approach that emphasizes common interests and engenders a great deal of mutual trust among negotiators on the genuine commitment of the negotiating partners to the advocated goals. Negotiations over tariffs and quotas require a more hard-nosed approach that demonstrates to all stakeholders that the negotiated outcome was the best that could be achieved under the circumstances. Problem solving negotiations fall somewhere in between. Each side to the negotiations must defend its interests, but also has to be able to demonstrate that both sides can gain from both the policy and the commercial aspects of an agreement. Understanding the nature of the parties and the subject matter of the negotiation is critical to the process of planning and preparation for a formal negotiation session. Terminology and descriptions of the various types of parties and form of negotiation follow: 1. 2. 3. Inter-governmental negotiations between governments the government of Pakistan negotiates with the government of India Intra-governmental negotiations within and among one government, usually between government agencies, political parties, or with constituent groups. Commercial negotiations between businesses, companies, corporations. This may include business negotiations related to contracts, sales agreements, investments, joint ventures, etc. Or, may involve negotiations within a business or trade association.
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4.
Internal business negotiations Within the business organization, company or corporation. Examples: management labor negotiations, human resources, inter-departmental, union negotiations, etc. Nongovernmental Organizations (NGOs)-business associations, trade associations, environmental, labor, human rights, development, etc.)
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Intra-group (within the NGO) a) b) c) d) Inter-group between and among other NGOs NGO-business organization NGO-governmental organization NGO-international governmental body (WTO, UN, WHO, ASEAN, etc)
Differences in Players, Resources, Styles, and Motivations With each identified type of negotiation and potential interest group involvement there will emerge different negotiating styles, techniques, and cultures. It stands to reason that groups of like-function (government to government) will employ more similar negotiating styles and protocols than groups that cross functional, experiential, and interest-based lines of demarcation. As groups cross from negotiations with familiar counterparts to dissimilar counterparts, the cadence of the negotiating dance will more likely be dissonant. In other words, people feel more comfortable negotiating with counterparts performing a similar role and dealing with like subject matter than with those representing different subject, professional, and cultural differences. It is one thing to acknowledge the differences inherent in a cross-over in negotiating with a group of different interest and professional focusit is quite another to adapt ones negotiating style and technique to accommodate or at least function with negotiators of diverse interest groups. As discussed, supra, a diplomatic culture exists among officials representing various governments. While language, background, and cultural differences may exist, the diplomatic culture plays upon common experience, educational training, and acceptance of protocols developed over decades so that negotiators can work with one another in an atmosphere that is predictable and based upon certain accepted norms, routines, and behaviors. While the subject of a trade dispute may not change, the parties to negotiations may vary from governmental representatives meeting with each other one day and those same representatives meeting with a cast of business or NGO representatives the next. While the differences should not be ignored, they can perhaps be minimized by planning and charting the divergent interests, histories, goals, and objectives.
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1. 2. 3. 4. Explain about Institutional Environment of International Business? What is TRIMS? Briefly explain its objectives? What kind of Conflict between Multinational and Government will occur? Explain. What is the use of WTO?
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Module V STRATEGY AND MANAGEMENT OF INTERNATIONAL BUSINESS

Introduction Nature of International Strategic Management International Business Strategy Global Competitive Strategy Global Marketing Strategy Production Management Strategy Organization of Human Resources in MNES International Finance Management
5.1 Introduction
International Strategic Management (ISM) is an ongoing management planning process aimed at developing strategies to allow an organization to expand abroad and compete internationally. Strategic planning is used in the process of developing a particular international strategy.
Module V - Strategy and Management of International Business
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An organization must be able to determine what products or services they intend to sell, where and how the organization will make these products or services, where they will sell them, and how the organization will acquire the necessary resources for these tasks. Even more importantly an organization must have a strategy on how it expects to outperform its competitors. When an organization moves from being a domestic entity to an international organization it must consider the possible broad complexities that accompany such a decision. In a domestic country, an organization must only consider one national government, a single currency and accounting system, one political and legal system, and usually a similar culture. Entering into one or more foreign countries can involve multiple governments, currencies, accounting systems, legal systems, and a large variety of languages and cultures. This can create numerous barriers to entry for an organization looking to expand internationally.
5.2 Nature of International Strategic Management

Strategic management is concerned with the process of formulating, implementing, and evaluating strategies to achieve a firms objectives. In concept, strategic management process in an MNC is similar to that in any other form of organization, the main complicating factors being the numerous country and regional environments it has to analyze and understand before considering the various strategic options. More time and efforts are required to identify and evaluate external trends and events in MNCs Geographic distances, cultural and national differences, and variations in business practices, often make communication between home offices and overseas operations difficult. Strategy implementation can be more difficult because different cultures have different norms, values and work ethics. Strategic management is critical to international business. An MNC needs to keep tract of its increasingly diversified operations in a continuously changing international environment. This need is particularly obvious when one considers the amount of FDI that has taken place in recent years. FDI has outgrown trade across the globe and this development necessitates the need to coordinate and integrate diverse operation with a united goal. There are examples of firms that are precisely doing this classic examples being Tata group. Also take the case of Ford Motor, which has re-entered the market in Thailand and despite a shrinking demand for automobiles there, is beginning to build a strong sales force to garner market share. The firms strategic plan is based on offering the right combinations of price and financing to a carefully identified market segment. In particular, Ford is working to bring down the monthly payments so that customers can afford a new vehicle. This is the same approach that Ford used in Mexico, where the current crisis of 1994 resulted in serious problems for many multinationals. Toyota is another multinational company which has benefited vastly from strategic management. The company is going beyond the automotive market. IN the process, Toyota is assessing environmental opportunities and threats and examine to internal strengths and weaknesses so that the firms strategic thrust can exploit its strength and sidestep any shortcomings.
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International Strategic Management Process Strategic Orientation
Before describing strategic management process of international business, it is useful to understand their strategic predisposition towards doings things in a particular way. The predisposition helps to determine specific decisions the firm will implement. There are four such predispositions: ethnocentric, polycentric, regiocentric and geocentric. Ethnocentric Disposition An MNC with an ethnocentric orientation will rely on the values and interests of the parent country in formulating and implementing the strategic plan. Primary emphasis is on profitability and the firm will try to run its operations overseas in the same way they are run at home. Polycentric Disposition An MNC with a polycentric predisposition will tailor its strategic plan to meet the needs of the host country culture. If the firm operates in more than one country, an overall plan will be adopted to meet specific needs of the host country. Each subsidiary will decide on the objective it wants to pursue depending on local needs. Profits will be ploughed back to the host country for expansion and the growth of the business operations Regiocentric Predisposition An MNC with a regiocentric predisposition will be interested in both profit as well as public acceptance an acceptance of both ethnocentric and polycentric orientations. The firm will use such a strategy that allows it to address to both local and regional needs. For example an MNC doing business in the EU will be interested in all its member countries. Geocentric An MNC with a geocentric approach will view operations from a global perspective. They offer global products with local variations and their employees belong to different parts of the globe. They hire the best people, notwithstanding their region or relation. The predisposition of an international business greatly influences its strategic management process. Some MNC for example are more interested in profit and or growth than they are in developing a comprehensive corporate strategy that exploits their potential. Others are more interested in large scale manufacturing that will allow them to compete on price across the country or region, as opposed to developing high degree responsiveness to local demand by tailoring a product need local needs. Some prefer to sell in countries where the cultures are similar to their own so that the same basic marketing orientation can be used throughout the regions. These orientations or predepositions greatly influence corporate strategy.
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Steps in Strategic Management Process Strategic Management process is necessary both at the headquarters of an MNC as well as at each of the subsidiaries. The global strategic management process duplicates the process followed in domestic companies; however, the variables and therefore, the process itself are far more complex in international business because of the difficulty in obtaining accurate and timely information; the diversity of geographic locations and the differences in political, legal, cultural and economic forces. Typically, the strategic management process of an international business comprises four major steps viz. 1) 2) 3) 4) Scanning of global environment Formulation of strategies Implementation of strategies Evaluation and control of strategies
Competitive Advantage and International Business While reviewing the opportunities in the international environment, a firm has to make crucial decisions about the entry mode it is likely to follow as entry mode decisions critically affect issues of control of the international venture. Internal focus firms with limited experience in working with external constituents are likely to prefer higher control over their international ventures. An operating strategy firms implement internationally is closely linked with a firms control preferences. Certain international strategies, like that of global integration, are likely to work better with high control of subsidiaries. On the other hand, multifocal strategies are likely to be successful when the subsidiary shares control with local partners. As the preceding paragraphs indicate, we take a path dependence approach in our analysis. Path dependence, according to Antonelli, defines the set of dynamic processes where small events have long-lasting consequences that economic action at each moment can modify yet only to a limited extent. The trajectory of a path dependent process however cannot be fully anticipated on the basis of the original events We take the position that preexisting or initial conditions do impact subsequent actions, and our research propositions have been developed to test whether there are specific relationships among competitive orientations, control preferences, pursuance of strategies, and subsequent performance. We agree with Antonelli (1997) that path dependence defines the set of dynamic processes where small events have long-lasting consequences. Theoretical Background Dunning (1995) makes a strong case for reappraising the existing system of market-based capitalism by suggesting that competitive market forces do not provide a complete explanation of economic development, nor do such forces necessarily ensure growth and dynamism in an uncertain world. A second and more insightful observation is that the traditional view of ownership and control of resources and competencies, the basic edifice of transaction cost analysis, is not necessarily the most efficient
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means of wealth generation. The traditional view holds that wealth creation is best achieved through competition, rather than through cooperation. In examining international business strategy, we focus on two types of strategies: (1) the mode of international entry firms choose to undertake, and (2) the international strategy firms choose to implement in order to fulfill their long-term business objectives. The Conceptual Model We look at three specific orientations a firm may have. These orientations are internal focus, external focus, and dual focus. We will examine two aspects of international business strategy. The first is the mode of entry into international markets, which we define as the degree of control a firm exercises in its foreign operations. For reasons of parsimony, we suggest that control can be classified as joint control and high control. Also for the purpose of this analysis, we examine three broad forms of international business strategy. The first is a strategy of global standardization, the second is one of market customization, and the third is a combination of the first two strategies called transnational strategy. Competitive Advantage Three Types of Competitive Advantage We reason that competitive advantage, defined in terms of external relationships and internal capabilities, drives international strategy. We suggest that the nature and texture of competitive advantage developed by a firm would influence it to prefer certain types of entry modes and follow particular international strategies over others. Competitive advantage can be categorized into three types. Internal Focus Firms. In developing their competitive advantage, some firms may choose to be more internally focused with the aim of maximizing economic rents from valuable, rare, inimitable, and nonsubstitutable resources. Most scholars of the resource-based view agree on the need to create unique and inimitable resources to differentiate a firm from its rivals, and to maintain sustained competitive advantage. External Focus Firms. For over a decade, inter-organizational arrangements based on certain relational attributes have become an important part of the strategy literature. The focus is on how traditional adversarial relationships between buyers and suppliers may be giving way to new forms of obligation contracting involving closer cooperation between buyers and their dependent suppliers. The primary focus of some firms in developing their competitive advantage is essentially relational based on such factors as trust and commitment. Dual Focus Firms. Commenting on changing environmental conditions, Moore (1993) suggests that in todays intensely competitive world, success is possible through being a part of a complex business ecosystem. Brandenburger & Nalebuff (1993) mention that competitive success comes from a winwin strategy, not from the old win-lose (zero sun game) with other firms. This is a process firms can successfully use with its competitors and its suppliers, and it includes sharing proprietary skills and technology with outsiders to enhance the overall competitive abilities of a given firm. Some scholars
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have come to the conclusion that economic ecosystems and mini ecologies provide a powerful explanation of firm behavior. Obviously such firms have well developed external relationships to successfully maintain interdependencies, and also possess valuable assets and resources that they exchange and leverage in the network.
5.3 International Business Strategy
5.3.1 Entry Mode and Control

In our analysis, we examine entry mode control that ranges from shared control to high control (Palenzuela & Bobillo, 1999). Researchers have pointed out that joint ventures are usually associated with some form of shared control, while wholly owned subsidiaries are typically associated with high control (Hill, Hwang & Kim, 1990; and Kobrin, 1989).
5.3.2 Two levels of Control

Shared control typically, control is shared through equity arrangement between the partners; there are also instances where non-equity control can be exercised. Work by Sohn (1994) indicates that the clan concept of social knowledge could be a more effective control mechanism compared to the more traditional form of control through equity ownership. He suggests that firms with a high level of social knowledge may maintain control in spite of low levels of equity. High Control - High control is preferred on the assumption that the objectives of the multinational and local partners will conflict. Multinationals prefer owned subsidiaries with high control as joint ventures (with shared control) are considered to be more costly to operate in terms of cost and efficiency. Moreover, high control in the form of wholly owned or majority owned subsidiaries continues to be a trend in industries typified by high technology and high firm-specific capabilities.
5.3.3 International Strategy

Global Integration Strategy: A strategy of global integration involves high resource commitment and high coordination, and requires a high degree of control to achieve it. Without control, a firm finds it more difficult to coordinate actions, carry out strategies, revise strategies, and resolve disputes that arise when two parties to a contract pursue their own interests (Davidson, 1982). A global strategy requires well developed internal capabilities which can be leveraged worldwide through high coordination and control. If a firm wishes to minimize risks that arise when dealing with external elements, it will prefer a global strategy resulting in maximizing internal linkages and coordination. It is also a strategy
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that is characterized by standardized needs, standardized practices and processes, and standardized customer services.
5.3.4 Multifocal Strategy

This is a strategy that is followed to satisfy strong local needs, and is negotiated to satisfy host government or local market requirements. It can be viewed as a tradeoff between high control and flexibility to respond to local requirements. Such a strategy of flexibility is undertaken with reduced resource commitment but a higher degree of shared control resulting in diffused interests between the entrant and its partners. It involves working with others in implementing joint strategies and it increases the entrants exposure and dependency. Multifocal strategies are usually associated with customizing products based on local knowledge, adapting to local markets, and providing localized service.
5.3.5 Transnational Strategy

This strategy, which combines the key aspects of global integration and multifocal strategies, is when a firm is able to meet local requirements along with a high degree of global integration. It is a complex strategy of being able to combine high customization with high standardization. It is the ability to form superior external networks and simultaneously leveraging internal resources optimally. It is the ability to extend control without necessarily extending hierarchies and having the flexibility to respond in a multitude of ways to changing environments. Such firms are able to produce a base product due to well developed internal capabilities, and adapt their products through network relationships. Such firms have true transnational capabilities and are able to respond most effectively to the dual pressures of global integration and local responsiveness. More importantly, such firms are able to standardize some links of the value added chain and meet the pressures of global integration, and decline others to fulfill pressures of local responsiveness. The transnational concept is an integrated framework of resources of technology, financial resources, creative ideas, and people that cannot be explained in simple centralization versus decentralization terms. A transnational strategy leads to reciprocal interdependence among a firms operations requiring complex coordination and control mechanisms. Such an organizational arrangement of integrated variety has great strategic potential because it would be best able to respond to variations in environments as well as to a great variety of linkages. The three international strategies that we consider in our model are global integration, multifocal, and transnational. Competitive Advantage and International Strategy We have pointed out earlier that there is considerable fragmentation in the discipline of international business strategy. Our aim in developing the conceptual model is not only to better understand the
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influence of competitive advantage on international business strategy, but also to integrate parts of the discipline by examining the relationship among competitive advantage, entry mode, international strategy, and performance. We categorize the competitive advantage that firms have into three distinct groups of firms: (1) internal focus; (2) external focus; and (3) dual focus. Based on the nature and type of competitive advantage, the choice of international entry that we specifically explore ranges from (1) shared control typical in joint ventures; (2) to high control typical in owned subsidiaries. The three international strategies in our conceptual model are: (1) a global strategy to address forces of global integration; (2) multifocal strategy to address pressures of local responsiveness; and (3) a transnational strategy that combine aspects global integration along aspects with high local responsiveness. Propositions Based on the discussion and arguments made so far, the following associations among competitive advantage, entry mode, and international strategy should be most salient. One, internal focus firms should be most closely associated with a high control entry mode and a global strategy. Two, external focus firms should be most closely associated with a shared control entry mode and a multifocal strategy. Finally, dual focus firms should be to handle both joint control and high control arrangements. In the case of internal- or external focus firms, there are restrictions on what mode of entry and strategy are appropriate. Figure 1 presents the path dependent nature of our assertions and propositions. Competitive Advantage, Entry Mode, and Performance Internal focus firms are likely to prefer high control over operations in order to protect their assets and other firm-specific resources, and am likely to prefer wholly (or majority) owned subsidiaries as preferred entry mode, and for these reasons unlikely to choose joint ventures. Such firms would do this in order to internalize operations and maximize returns on firm-specific attributes. However, these firms are likely to perform poorly in joint venture arrangements as they do not have the capability to meaningfully share control. We propose the following relationship: Proposition 1a: Internal focus firms have a greater likelihood of choosing wholly owned or majority owned subsidiaries as the preferred entry mode. Proposition 1b: For internal focus firms, use of wholly owned or majority owned subsidiaries is likely to result in higher performance than the use of joint ventures. As opposed to internal focus firms, external focus firms are able to share control more easily as they have well developed relational skills. External focus firms will be able to form relatively successful joint ventures, and may be prepared to enter less favorable locations because it has the capability to manage its external environment in a superior manner. External focus firms are unlikely to choose wholly or majority owned subsidiaries as they have limited internal assets to leverage, and are likely to perform poorly as wholly or majority owned subsidiaries which leads to the following propositions:
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Proposition 2a: External focus firms will have a greater likelihood of choosing joint ventures as the preferred entry mode. Proposition 2b: For external focus firms, use of joint ventures is likely to result in higher performance than the use of wholly owned or majority owned subsidiaries. Competitive Advantage, International Strategy, and Performance Internal focus firms would prefer to leverage their firm-specific capabilities in international operations. To do this it would need to integrate various overseas units to generate scale economies; however, this is possible through high resource commitment and high internal coordination. Such coordination is required for plant loading, worldwide logistics, and transfer pricing. It is important to note that high volumes and scale economies can be achieved through a high degree of standardization. These, in turn, constitute the basic components of a global integration strategy. For internal focus firms, not only is a global integration strategy appropriate, but because of the inherent strengths such firms have to support such a strategy, performance will be enhanced. We, therefore, propose the following: Proposition 3a: Internal focus firms are more likely to follow a strategy of global integration. Proposition 3b: For internal focus firms the use of a global integration strategy is likely to result in higher performance than the use of a multifocal strategy. According to Hill, Hwang & Kim (1990), when risks are high due to political instability, concerns over expropriation, and host government mandates, firms prefer to limit their exposure not only through shared control, but also through joint strategies to spread the uncertainty. Such arrangements, which are multifocal in nature, entail a higher degree of risk as it involves working with others in implementing joint strategies as it increases a firms exposure and dependency upon other firms. External focus firms, with their strong relational skills, can use diffused interests to their advantage by focusing on customized products that require local knowledge, adapting to local markets, and providing localized service (Roth & Morrison, 1990). On account of external focus firms ability to share control, manage risk, work with others, and follow multiple objectives, we propose: Proposition 4a: External focus firms are more likely to follow a multifocal strategy. Proposition 4b: For external focus firms the use of a multifocal strategy is likely to result in higher performance than the use of a global integration strategy. Entry Mode and International Strategy This important aspect of international management, the relationship between entry mode and international strategy, continues to remain underdeveloped in the international business literature. Based on the arguments associated with the propositions discussed so far, we suggest that there is a strong association between high control and a global integration strategy, and between shared control and a multifocal strategy which leads to the following propositions?
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Proposition 5a: Firms that enter through a wholly owned or majority owned process are more likely to follow a global strategy. Proposition 5b: Firms that enter through a joint venture process are more likely to follow a multifocal strategy. Transnational Strategies Dual focus firms are able to simultaneously form superior networks and leverage their resources optimally, a capability not possible for external focus or internal focus firms. Dual focus firms are, in effect, able to extend control without necessarily extending hierarchies, and thus be able to respond in a variety of ways to their changing environments. Dual focus firms are able to develop true transnational capabilities (Bartlett & Ghoshal, 1989), and are able to respond more effectively to pressures of global integration and local responsiveness. In essence, dual focus firms have the capabilities to formulate and implement transnational strategies which leads us to propose the following: Proposition 6a: Dual focus firms that follow a transnational strategy are more likely to have higher performance than the use of a transnational strategy by internal focus or external focus firms. We argue that dual focus firms following a strategy of global integration will outperform internal focus firms that follow a strategy of global integration for a number of reasons. Dual focus firms will be able to leverage their resources through external networks and alliances more effectively than internal focus firms. Such leveraging will allow higher levels of exchange of skills and resources, which include developing more effective downstream distributors and other channel related infrastructure. While dual focus firms can match the internal capabilities of internal focus firms, they have the importance of relational skills to form linkages and networks. Based on this, we suggest: Proposition 6b: Dual focus firms that follow a global integration strategy are likely to outperform internal focus firms that follow a global strategy. For similar kinds of reasons that suggest that dual focus firms have important advantages over internal focus firms, dual focus firms have important advantages over external focus firms. While both dual focus and external focus firms are matched on external relationships, dual focus firms have superior internal capabilities that allow them to produce better goods and leverage their internal resources better. Dual focus firms have superior upstream and manufacturing strengths, and have matching relational skills compared to external focus firms. Thus, in following a multifocal strategy, dual focuses firms will perform equally well on relational capabilities, but will outperform on account of superior internal capabilities. Based on this, we make the following proposition: Proposition 6c: Dual focus firms that follow a multifocal strategy are likely to outperform external focus firms that follow a multifocal strategy. The conceptual model we have developed has addressed the original objectives that we have mentioned at the beginning of this paper. We have defined competitiveness in very specific terms, and thus have
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avoided the generalities that are occasionally used. Statements like core capabilities and core competencies have little value unless very specific concepts and definitions are provided by which these terms can be measured and important interrelationships be identified. We have also extended the concept of competitive advantage to include both an internal as well as an external perspective; an extension we believe better captures this complex phenomenon. Our conceptual model attempts to logically address the overall relationship through three major constructs, namely competitive advantage, strategy, and performance. We have also integrated the two important aspects of international managemententry mode and international strategytwo streams that have typically been researched separately. Our propositions specifically address the relationships of the constructs that we have highlighted. We outline the three different categories of competitive advantage with the two types of entry, and the three international strategies. Internal focus firms, we argue are driven by high control, and a need to leverage their well developed internal capabilities through volume and standardization. External focus firm prefer to share control on account of strong of relational skills, and prefer to use their skills to adapt to market needs through local partners. In the case of dual focus firms, the mediation effect of entry mode is relatively less important as such firms have the skills to manage a wide variety of control mechanisms and organizational arrangements successfully. Dual focus firms are also able to execute a range of strategies more successfully when compared to other types of firms International Financial Management Financial management entails planning for the future of a person or a business enterprise to ensure a positive cash flow. It includes the administration and maintenance of financial assets. Besides, financial management covers the process of identifying and managing risks. The primary concern of financial management is the assessment rather than the techniques of financial quantification. A financial manager looks at the available data to judge the performance of enterprises. Managerial finance is an interdisciplinary approach that borrows from both managerial accounting and corporate finance. Some experts refer to financial management as the science of money management. The primary usage of this term is in the world of financing business activities. However, financial management is important at all levels of human existence because every entity needs to look after its finances. Financial Management Levels Broadly speaking, the process of financial management takes place at two levels. At the individual level, financial management involves tailoring expenses according to the financial resources of an individual. Individuals with surplus cash or access to funding invest their money to make up for the impact of taxation and inflation. Else, they spend it on discretionary items. They need to be able to take the financial decisions that are intended to benefit them in the long run and help them achieve their financial goals.
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From an organizational point of view, the process of financial management is associated with financial planning and financial control. Financial planning seeks to quantify various financial resources available and plan the size and timing of expenditures. Financial control refers to monitoring cash flow. Inflow is the amount of money coming into a particular company, while outflow is a record of the expenditure being made by the company. Managing this movement of funds in relation to the budget is essential for a business. At the corporate level, the main aim of the process of managing finances is to achieve the various goals a company sets at a given point of time. Businesses also seek to generate substantial amounts of profits, following a particular set of financial processes. Financial managers aim to boost the levels of resources at their disposal. Besides, they control the functioning on money put in by external investors. Providing investors with sufficient amount of returns on their investments is one of the goals that every company tries to achieve. Efficient financial management ensures that this becomes possible. Strong financial management in the business arena requires managers to be able to: 1. 2. 3. 4. 5. 6. 7. 8. Interpret financial reports including income statements, Profits and Loss or P&L, cash flow statements and balance sheet statements Improve the allocation of working capital within business operations Review and fine tune financial budgeting, and revenue and cost forecasting Look at the funding options for business expansion, including both long and short term financing Review the financial health of the company or business unit using ratio analyses, such as the gearing ratio, profit per employee and weighted cost of capital Understand the various techniques using in project and asset valuations Apply critical financial decision making techniques to assess whether to proceed with an investment Understand valuations frameworks for businesses, portfolios and intangible assets.
5.4 Global Competitive Strategy

Global Financial System The global financial system (GFS) is a financial system consisting of institutions and regulators that act on the international level, as opposed to those that act on a national or regional level. The main players are the global institutions, such as International Monetary Fund and Bank for International Settlements,
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national agencies and government departments, e.g., central banks and finance ministries, and private institutions acting on the global scale, e.g., banks and hedge funds. Deficiencies and reform of the GFS have been hotly discussed in recent years. The history of financial institutions must be differentiated from economic history and history of money. In Europe, it may have started with the first commodity exchange, the Bruges Bourse in 1309 and the first financiers and banks in the 14001600s in central and western Europe. The first global financiers the Fuggers (1487) in Germany; the first stock company in England (Russia Company 1553); the first foreign exchange market (The Royal Exchange 1566, England); the first stock exchange (the Amsterdam Stock Exchange 1602). Milestones in the history of financial institutions are the Gold Standard (18711932), the founding of International Monetary Fund (IMF), World Bank at Bretton Woods, and the abolishment of fixed exchange rates in 1973. Global Competitive Strategy Globalization has fundamentally changed the game of business. Strategic frameworks developed for the analysis of purely domestic business necessarily fall short in the international business context. Managers and business students require new approaches to understand and cope with these far-reaching changes. We must learn to think globally in order to succeed. Global Competitive Strategy shows how we can do this by providing a unique set of strategic tools for international business. Such tools include the star analysis that allows strategy makers to integrate geographic information with market information about the global business environment. Also introduced is the global value connection that shows managers how to account for the gains from trade and the costs of trade. Global Competitive Strategy is a great work. With its focus on the tremendous increase in global competition and the variety of global markets. Managers face competitive challenges in the best of times, but globalization raises the level of those challenges exponentially. Using the best from modern research, world-class economist Daniel Spulber unravels these managerial challenges and offers keys to competing successfully in the global market.
5.5 Global Marketing Strategy

The Oxford University Press defines global marketing as marketing on a worldwide scale reconciling or taking commercial advantage of global operational differences, similarities and opportunities in order to meet global objectives. (i) Worldwide Competition One of the product categories in which global competition has been easy to track in U.S.is automotive sales. Three decades ago, there were only the big three: General Motors, Ford, and Chrysler. Now,
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Toyota, Honda, and Volkswagen are among the most popular manufacturers. Companies are on a global playing field whether they had planned to be global marketers or not. (ii) Evolution to global marketing Global marketing is not a revolutionary shift, it is an evolutionary process. While the following does not apply to all companies, it does apply to most companies that begin as domestic-only companies. (iii) International Marketing If the exporting departments are becoming successful but the costs of doing business from headquarters plus time differences, language barriers, and cultural ignorance are hindering the companys competitiveness in the foreign market, then offices could be built in the foreign countries. Sometimes companies buy firms in the foreign countries to take advantage of relationships, storefronts, factories, and personnel already in place. These offices still report to headquarters in the home market but most of the marketing mix decisions are made in the individual countries since that staff is the most knowledgeable about the target markets. Local product development is based on the needs of local customers. These marketers are considered polycentric because they acknowledge that each market/ country has different needs. (iv) Multinational Marketing At the multi-national stage, the company is marketing its products and services in many countries around the world and wants to benefit from economies of scale. Consolidation of research, development, production, and marketing on a regional level is the next step. An example of a region is Western Europe with the US. But, at the multi-national stage, consolidation, and thus product planning, does not take place across regions; a regiocentric approach. (v) Global Marketing When a company becomes a global marketer, it views the world as one market and creates products that will only require weeks to fit into any regional marketplace. Marketing decisions are made by consulting with marketers in all the countries that will be affected. The goal is to sell the same thing the same way everywhere. (vi) Elements of the global marketing mix The Four Ps of marketing: product, price, placement, and promotion are all affected as a company moves through the five evolutionary phases to become a global company. Ultimately, at the global marketing level, a company trying to speak with one voice is faced with many challenges when creating a worldwide marketing plan. Unless a company holds the same position against its competition in all markets (market leader, low cost, etc.) it is impossible to launch identical marketing plans worldwide.
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(vii) Product
A global company is one that can create a single product and only have to tweak elements for different markets. For example, Coca-Cola uses two formulas (one with sugar, one with corn syrup) for all markets. The product packaging in every country incorporates the contour bottle design and the dynamic ribbon in some way, shapes, or form. However, the bottle or can also includes the countrys native language and is the same size as other beverage bottles or cans in that country. (viii) Pricing Price will always vary from market to market. Price is affected by many variables: cost of product development (produced locally or imported), cost of ingredients, cost of delivery (transportation, tariffs, etc.), and much more. Additionally, the products position in relation to the competition influences the ultimate profit margin. Whether this product is considered the high-end, expensive choice, the economical, low-cost choice, or something in-between helps determine the price point. (ix) Placement How the product is distributed is also a country-by-country decision influenced by how the competition is being offered to the target market. Using Coca-Cola as an example again, not all cultures use vending machines. In the United States, beverages are sold by the pallet via warehouse stores. In India, this is not an option. Placement decisions must also consider the products position in the market place. For example, a high-end product would not want to be distributed via a dollar store in the United States. Conversely, a product promoted as the low-cost option in France would find limited success in a pricey boutique. (x) Promotion After product research, development and creation, promotion (specifically advertising) is generally the largest line item in a global companys marketing budget. At this stage of a companys development, integrated marketing is the goal. The global corporation seeks to reduce costs, minimize redundancies in personnel and work, maximize speed of implementation, and to speak with one voice. If the goal of a global company is to send the same message worldwide, then delivering that message in a relevant, engaging, and cost-effective way is the challenge. Effective global advertising techniques do exist. The key is testing advertising ideas using a marketing research system proven to provide results that can be compared across countries. The ability to identify which elements or moments of an ad are contributing to that success is how economies of scale are maximized. Market research measures such as Flow of Attention, Flow of Emotion and branding moments provide insights into what is working in an ad in any country because the measures are based on visual, not verbal, elements of the ad.
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Global Marketing Advantages and Disadvantages Advantages Economies of scale in production and distribution Lower marketing costs Power and scope Consistency in brand image Ability to leverage good ideas quickly and efficiently Uniformity of marketing practices Helps to establish relationships outside of the political arena Helps to encourage ancillary industries to be set up to cater for the needs of the global player
Global Marketing Strategy Other marketing activities also need to be examined carefully for their globalization potential. Dell Computer is a good example of a company which has replicated its direct selling practices across the world. In 1998, Dell generated approximately 31% of its sales in overseas markets. Dells sales persons directly target large international accounts. Retail customers can dial toll free one of its call centres in Europe and Asia. A truly global marketing strategy would aim to standardize some elements of the marketing mix across the world, while customizing others. The correct approach would be to identify the various value chain activities within the marketing function and decide which of these can be performed on a global basis and which can be localized. Typically, marketing includes the following activities: Market research. Concept & idea generation. Product design. Prototype development & test marketing Positioning Choice of brand name Selection of packaging material, size and labeling Choice of advertising agency
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Development of the advertising script Execution of advertisements Recruitment and posting of sales force Pricing Promotion
Selection and management of distribution channels.
Some of these activities are amenable to a uniform global approach. Others involve a great degree of customization. Within a given activity, parts can be globalized and others performed locally. Product Development Product design & development is an activity where the potential to globalize needs to be examined carefully. A globally standardized product can be made efficiently at a low cost but may end up pleasing few customers. On the other hand, customized products targeted at different markets across the world may be too expensive. The trick, as in the case of other value chain activities is to identify those elements of the product which can be standardized across markets and those which need to be customized. Japanese companies such as Sony and Matsushita have been quite successful in marketing standardized versions of their consumer electronics products. These companies had limited resources during their early days of globalization and identified features which were universally popular among customers across the world. Global economies of scale helped them to price their products competitively. At the same time, these companies laid great emphasis on quality. As a result, as their products, even without frills, began to appeal to customers. Many of Sonys consumer electronics products are highly standardized except for the parts that meet national electrical standards. Canon offers the interesting example of a Japanese company that took into account global considerations while developing a new product. In its domestic market, customer requirements were quite different. Photocopiers in Japan were expected to copy all sizes of paper. Canon felt that the designing around the requirements of the US, the largest market for photocopiers in the world made sense. In the process, the company deliberately overlooked some of the features required by the Japanese market, to keep its development costs under control. In the case of industrial products, standardization may become unavoidable if global customers coordinate globally their purchases. This seems to be true in the PC industry and companies such as Dell are taking full advantage of this trend. This is likely to accentuate further, as companies increasingly feel the compelling need to coordinate their corporate information systems on a global scale. MNCs often choose to replicate the computer system in their headquarters to minimize the costs involved in writing new programs and training staff.
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In industries characterized by high product development costs and great risk of technological obsolescence, there is a great motivation for developing globally standardized products and services. By serving large markets, costs can be quickly recovered. Even in the food industry, where tastes are largely local, companies are looking for opportunities to standardize. Even if identical offerings cannot be made in different markets, companies are developing a core product with minor customization, such as a different blend of coffee, to appeal to local tastes. In a globalized economy, there is pressure on companies to improve efficiencies by offering standard products to the extent possible. There are pitfalls however to be avoided. Customer preferences vary across countries. Let us say all these are carefully taken note of and some average preference arrived at. Based on this, if a company develops a new product, it may well and up pleasing no one. As Kenichi Ohmae has remarked in his book, The Borderless World: When it comes to product strategy, managing in a borderless economy doesnt mean managing by averages. It doesnt mean that all tastes run together into one amorphous mass of universal appeal. And it doesnt mean that the appeal of operating globally removes the obligation to localize products. The lure of a universal product is a false allure. Some products of course tend to be more global than the others. These include cameras, watches, pocket calculators, premium priced fashion goods and luxury automobiles. In the case of many industrial products, purchase decisions are normally taken on the basis of performance characteristics. Considerable scope exists for standardization that can cut costs. However, even for these products, local customization may be required in engineering, installation, sales, service and financing schemes. In the case of financial services, institutional products tend to be more global than the retail ones. Consider a product like cars. Traditionally, car manufacturers have developed hundreds of models to meet the needs of different markets without exploring the possibilities that exist for standardization. Proliferation of models has resulted in unused capacities and inefficiencies. In the global automobile industry today, substantial excess capacity exists. Under these circumstances, car manufacturers are looking for ways to cut costs. One approach has been to select common platforms and build models of different shapes around these platforms. The idea here is that the basic functionality of a car can be extended globally while features and shape are customized to appeal to different consumer tastes in various parts of the world. Ford and Toyota have made a lot of progress in standardizing the platforms. Other automobile companies are also laying a lot of emphasis in this regard. Market Research Now, let us move on to another important marketing activity, market research. Some elements can probably be standardized. For example, the sample to population ratio can be controlled globally. The information to be collected for each product category can also be standardized. However, questions have to be tailored taking into account the sensitivity of both the local government and the local people. In particular, personal and embarrassing questions have to be avoided in certain countries. The actual task of administering the questionnaire and collecting data has of course to be performed locally.
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Even if questionnaires have to be customized to suit local requirements, a global approach to marketing research efforts can help in improving efficiency. For example, clusters of countries might need the same questionnaire. Global coordination is also necessary to facilitate sharing and transfer of knowledge. The global head of market research has the important job of ensuring that each country is aware of not only the research activities it is carrying out but also of the activities being conducted in other countries. A systematic process of collecting inputs relating to research methodology and data from different parts of the world can help in the formulation and implementation of a globally coordinated market research strategy. Advertising Advertising is obviously a critical marketing activity. Consider the choice of advertising agency. A totally decentralized approach would mean selection of different agencies by different subsidiaries. While local agencies may feel they are in the best position to understand the needs of the local markets, no global company can afford such an uncoordinated approach towards advertising. Nestle had been employing over a hundred different agencies. As the company looked for global branding opportunities, coordinating the activities of so many agencies became a major problem. Nestle decided in favour of retaining only a few agencies Mc Cann Ericsson, Lintas, Ogilvy & Mather, JWT, Publicis / FCB and Dentsu. Peter Letmathe, Nestle CEO explains the role of an advertising agency in the companys globalization efforts: To us, the most important thing is to have dedicated teams. Mc Cann for instance has 10 people working only with Nestle. I see them as an extended arm of my communications team. They visit every six weeks to tell us what they are doing around the world. Nestle subsidiaries have encouraged their local agencies to tie up with the companys global agencies. The rationalization of worldwide communications efforts has helped Nestle achieve efficiencies in the case of products such as coffee, ice creams and chocolates. While Nestle has also made attempts to transfer advertising expertise across countries, there are obvious limits. Letmathe himself has articulated some of the difficulties involved in using the same advertisement across different countries: Sometime ago, Chile produced an outstanding Nescafe commercial. In a little house by a lake, a man gets up early and tries to wake his son (who prefers to stay in bed) to go fishing. We see the disappointed father sitting in the morning mist at the lake. Then the son reconsiders the decision, get up and makes a cup of coffee and brings it to his father for a moment of spontaneous renewal. Their whole relationship is built up through coffee. Now, the same commercial, projected in a different market can bring completely different connotations. In Paris, you might even provoke ecological feelings that look almost like an environmental statement. The same images are perceived totally differently. Pricing When it comes to pricing, both global and local approaches can be used depending on the specific situation. Consider the virtual bookstore Amazon. Com. The store sells books which are essentially branded products. Customers typically have a distinct preference for a particular book. For
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Amazon.com, global pricing probably makes sense. On the other hand in the car industry, inspite of claiming to be global, pricing has to take into account local factors. Companies such as Ford and General Motors are realizing that the Indian customers are unwilling to pay Rs. 7 8 lakhs (based on an exchange rate of Rs. 43/$) for the same models which cost $ 15 18,000 in the US and Western Europe. This is putting pressure on them to look for ways to cut costs, indigenise and offer cheaper models. Sometimes global pricing becomes difficult because of different levels of competition in different markets. Even a company like GE which follows global pricing for its jet engines makes suitable adjustments for local competition. Using a uniform price relative to competitors appears to make sense in many cases as it protects market share while maintaining a consistent positioning. Positioning A global positioning of products helps in improving the efficiency and effectiveness of marketing programs. On the other hand, differing usage patterns, buying motives and competitive pressures across countries necessitate the need for positioning products uniquely to suit the needs of individual markets. Wherever possible, a global positioning need to be used as it ensures that money is wisely spent on building the same set of qualities and features into products. Global positioning can also reduce advertising costs. However, as mentioned earlier, uniform positioning without taking into account the sensitivities of local markets can result in product failures. Sometimes, local positioning has to take into account market realities. For a long time, Citibank has been serving the premium segment in India. To open a Savings Bank account, the minimum deposit required is Rs. 3 lakhs. While this may sound reasonable in dollar terms ($ 7500) it is obviously beyond the reach of the Indian middle class. Citibank has probably realized that targeting the mass market would be a Herculean task in a vast, predominantly rural country like India where the Government also has imposed several restrictions on the expansion of foreign banks. Hence its decision to restrict itself to Indias major cities and target wealthy individuals and blue chip corporate. Citibanks up market positioning needs to be viewed in this context. Now, Citi seems to have realized the need for offering products and services for the mass market. Global positioning of products often evolves over time. Ford offers some useful insights. Fords first global product, the Escort was launched individually in different countries. Each country not only came up with its own positioning but also developed its own advertising message using local agencies. In some countries, the product was positioned as a limousine and in others as a sports car. Compared to the Escort, Fords new compact, Focus is a classic example of global positioning. The Focus is being launched across markets as a car with a lot of design flair, plenty of space, great fuel efficiency and engineering features to promote safety. Ford has employed only one advertising agency for the launch of the Escort. Nestle uses positioning documents for the worldwide brands as well as important regional brands. These documents are prepared by the respective Strategic Business Units in consultation with marketing personnel from different parts of the world and approved by the general management. In the late 1990s, roughly 40% of Nestles total sales were generated by products covered by the Nestle corporate
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brand. For some products such as pet foods, Nestle has chosen to keep the brands as distant as possible from the Nestle brand name. In the case of mineral water also, Nestle does not use its corporate name. Letmathe explains: We felt that people buying water are looking for the purity of the source whereas our seal is that of a manufacturer. So we set up a special institute, Perrier Vittel, which puts its own guarantee on mineral water. Selling If a customer in Portugal makes a local call, it is automatically forwarded to the call center in France where a Portuguese speaking sales representative answers the customers questions. To be closer to overseas customers in Europe and Asia, Dell has a plant in Limerick, Ireland and another in Penang, Malaysia. Dell has attempted to configure its factories similar to its Austin plant, in the US. The plant at Ireland, is for example very close to the plants of its suppliers such as Intel (microprocessors), Maxtor (Computer hard drive) and Selectron (Computer motherboard). Such arrangements facilitate the smooth execution of Dells direct selling; build to order, just in time model.
5.6 Production Management Strategy

Production Management Production systems play a very important role in achieving organizational excellence. But the lack of proper planning, co-ordination and control often affects the capabilities of these systems because of which these systems are not utilized fully and effectively leading to many undesirable situations forcing many organizations to become less competitive. A number of organizations worldwide have achieved and sustained excellence by effective production management. Effective production management involves understanding of the characteristics of various types of production systems, identification of the dynamics of the different phases of the management process, realizing the potential of different analytical tools, learning the nuances of the implementation of these tools, visualizing the impact of various uncertain situations and developing the ability to react under various scenarios to achieve consistently excellent business results. There are evidences to show how a number of organizations achieved world class status by effective management of their production systems. These organizations achieved superior quality, higher productivity, perfect delivery performance, overall customer satisfaction and enterprise excellence all with lower cost. Production management, alternatively referred to as manufacturing management, is required for transforming raw materials and partly, fabricated materials into finished products. Production management does not imply management of productive process alone, but it covers all their activities which go into the making of production. To make production a concrete reality, one, must pay heed to the factors of production like land, labour, capital and organization, or to speak in the language of business, materials, men, money, machines and methods. Production management thus calls for the work of planning and control pertaining to each of these factors of production.
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Production management does not involve a mechanical assemblage of relevant factors. In contrast to mere transformation of raw materials into finished products, it aims at transmuting and permuting resources of higher productivity so that the greatest outputs are obtained from the least inputs. With its end in views, production management embraces the productive process too and involves planning, directing and controlling operations till their successful completion. Quality, quantity, cost and time of production has an important bearing on productivity of the manufacturing enterprise. Accordingly, it is the task of production management to see that effective utilization of resources is made, time is shortened, wastes and scrapings are avoided, and harmonious working is made to prevail in the plant. For effective managerial performance, the work of production department is required to be organized on sound lines. All the principles and practices of organizing are to be applied in building a sound structure for improving the result of production management. Successful production management is not practicable without the existence of an appropriate organization structure. Consequently, managerial efforts are to be directed in designing an organization structure that conforms to the needs of the product, size of the enterprise and availability of production facilities. Organizing for production may be conceived in broader sense to include some aspects of works engineering or works organization like plant layout and factory building. The problems of production management differ from case to case and are mainly related to the system of production. There are several systems of production which determine the magnitude of production work and the problems to be tackled in manufacturing operations. Hence, a familiarity with the different systems of production is required for understanding the intricacies of production management. Of course, the system of production is dictated in a particular case by the volume of sales and the nature of product. The quantity to be produced is nothing but an answer to the question of what can be sold. In the ultimate analysis, therefore, sales are the regulator of a system of production. The management of transformation process of inputs into output is the essence of production management. In present competitive world the production process in every enterprise needs some effective and scientific planning as well as proper control. Thus production management can be defined as Management which by scientific planning and regulation sets into motion the part of an enterprise to which it has been entrusted the task of actual transformation of inputs into output. In the words of Mr. E.L. Brech, Production Management then becomes the process of effectively planning and regulating the operations of that part of an enterprise which is responsible for the actual transformation of materials into finished products. This definition appears to be incomplete as it does not include the human factors involved in a production process. It lays stress only on the materialistic features. In broader sense, production management actually deals with decision making related to production processes, so that the resulting goods and services are produced in accordance with the quantitative specifications and demand schedule with minimum cost. To attain these objectives the two main activities of Production Management are the Design and Control of production systems.
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In production management effective planning and control are essential. In the absence of effective planning and regulation of any production activity the goals cannot be achieved, the customers may not be satisfied and ultimately certain activities may be closed which may lead to social evils. Measurement of Work In an engineering sense efficiency can be simply stated as the ratio of useful energy obtained to energy applied. We can all understand that. Put succinctly, that is what is really meant by efficiency of production, but the difficulty is to see the relationship between input and output of production, or to measure performance. Which brings us right to the heart of the problem of efficiency of production: how to measure performances. There is usually some difficulty about measuring the comparative performance of several departments in a Company or different companies. If two factories are turning out the same product which is measured in tons or feet, then overall cost per ton or per foot is a measure of performance which can be obtained readily and used for comparison. But how does one compare the costs or efficiency of two factories or department s making dissimilar products? Cost per ton or unit is no good. As between two different firms, only the percentage net profit is any measure, and that is affected by the type of market and selling cost which are not production costs. And between different departments in the same firm there would seem to be, at first sight, no measure of efficiency on a common and therefore comparable basis. If, however, the amount of effort (or cost-material, labour and overhead services) which should have been sued to make a given quantity of a product is known and also the amount actually used, then surely the correct amount as a proportion of the actual amount is a measure of performance of efficiency. It is in reality an efficiency formula again, output over input. The real value of output, in effort, hours or s.d., is the amount of cost which goes out of the factory or department in a useful form, i.e., it does not include all wastage and excess costs, avoidable, and of no benefit to customer or company. And input is the total of all effort and costs absorbed. Including excess costs. Organization of Production Planning Department The work of a Production Planning Department generally falls into three sections, dealing with three stages of the sequence of operations. They are; i. ii. iii. Compiling and recording facts. Developing plans. Putting plans into operation and controlling results. In the first stage and section, information is gathered together, recorded and filed in a way which is suitable for use by planners, and so that reference to it is easy and rapid. The information is of three kinds, relating to:
a) Customers orders and requirements; b) Stocks of materials and components;
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c) Plant available, capacities, operations and times. Unless the organization is of such a size that each kind of information is dealt with in a separate section, it is advisable for all of it to be handled by one section under the supervision of a person skill din the work. Its organization is mainly a problem of filing and entering-up figures or records form vouchers, i.e., transferring information and striking balances. It can usually be staffed with Juniors, female, or relatively unskilled labour, but must be carefully supervised and checked by very reliable people. The absolute accuracy and therefore double checking required in banks is not essential, but inaccuracies can be troublesome and costly. The second stage and section comprises the vital part of planning. It is her that the effectiveness or indifference of results is ensured. And where the ability to scheme, think ahead and take all factors into account is so essential. It is a job mainly done on paper, juggling as it were with figures and charts. Sales budgets must be broken down into or integrated with long-term production plans, factory and departmental plans formulated, and weekly or daily or even hour-by-hour loads prepared. In small factories a few simple charts or schedules suffice, but in very large organizations a vast amount of detailed information, in the form of masses of figures, flows into the section, and must be rapidly and regularly collated and reissue for action. Extreme tidiness is essential, and if those concerned are not to be bogged down by a continuous stream of insistent inquiries demanding attention, much of the work must so be organized as to be dealt with in a routine manner by juniors. The third stage consists of translating the plans into instructions and can be mainly of a clerical nature. In practice, however, it is at this stage that a certain amount of decentralization is advisable, and the hourby-hour machine or operation loading and the actual issue of jobs to operators is done either in or adjacent to the Formans office, or in a shop office. Progress work, that is, checking performance against plans and reporting results (with recommendations for corrective action and requests for urgent actions) to foremen or other supervisors, which is really an aspect of control, is frequently carried out form the same of and even by the same persons. The complexity of an organization structure for production planning depe4nds on the type of industry or manufacture rather than its scale. In mass-production and continuous-process manufacture, production planning consists of balancing the flow of materials (or components) from outside or component manufacturing departments, with consumption by the factory or assembly departments. Particularly is this so in the automobile or similar industries, where a good deal of preliminary work on materials in subcontracted, no large stocks of materials are kept (or could be for the immense consumption rate) and a small interruption to production affects a large part of the factory and is very expensive. In those factories engaged on batch production of partly standardized products there is the added complexity of setting-up (time and cost), varying batch sizes, and the synchronization of finishing dates for parts and sub assemblies when batches vary so much. It is predominantly a question of continual adjustment in order to maintain balanced loads on departments and to correct for unforeseen delays. When the product is designed to customers requirements, the total process time is increased by the time required for design or preparation for each order, and consequently the period over which planning must extend is greater, making the problem more complex. Production planning is most complex when the product
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is mainly to customers requirements, but is designed to incorporate many standard parts kept in stock. When the number of orders exceeds something like 50 per week, the amount of information to be handled becomes large and the department correspondingly. Production Planning Methods The purpose of production order is to provide information about various operations involved in a production process. Once a production order is formulated, there arises the necessity to determine that when and where each operation is to be done. The reasons in that the operations described in a production order may be executed in several ways to get the final product and one may like to use a production strategy which makes most effective use of an, machine and material in the system. The best strategy is planned through the methods of Routing and Scheduling. Thus scheduling and routing is the final stage in production planning and have the following objectives: i. ii. to prescribe where and by whom each operation necessary to manufacture a product is to be executed. This is known as routing. the establishment of times at which to begin and/or complete each even or operation. This is termed as scheduling.
Plant Layout Layout problems are fundamental to every type of organization/enterprise and are experienced in all kinds of undertakings. Housewife must arrange her kitchen, retailer must arrange his counters and display the items in such a manner which facilitates movement and attract the attention of customers, office management positions the desks, tables and other equipment in such a way that it facilitates the flow of work. The manufacturing organizations must arrange their facilities, not only the department within the factory but also the plant, stores and services so as to achieve smooth flow of products. The adequacy of layout affects the efficiency of subsequent operations. It is an important perquisite for efficient operations and also has a great deal in common with many of the problems. The simplest of situations with comparatively fewer items to arrange have many alternatives available. Import the layout decisions were based merely on intuition, experience, judgment and some sort of improvisation but with increase in the complexities of organizations the layout problems are solved scientifically. Once a decision about location of the plant has been taken, next important problem before the management is to plan suitable layout for the plant. Efficiency and performance of good machines and sturdy building depend to a great extent on the layout of a plant. Plat layout is the method of allocating machines and equipment, various production processes and other necessary services involved in transformation process of a product with the available space of the factory so as to perform various operations in the most efficient and convenient manner providing output of high quality and minimum cost. In the words of James Lundy, layout identically involves the location of space and the arrangement of
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equipment in such a manner that overall operating costs are minimized. Alternately, plant layout is an effort to arrange machines and equipment, and other services within a predesigned building ensuring steady, smooth and economical flow of material. Planning the layout of a plant is a continuous process as there are always chances of making improvements over the existing arrangement especially with shifts in the policies of management of techniques of production. The disposition of the various parts of a plant along with all the equipment used is known as plant layout. It should be so designed that the plant functions most effectively. Layout problems are common to all kinds of organization. A retailer must arrange his counter, display of items etc., office management must position desks, tables etc. in such a way that it facilitates the flow of work. A manufacturing organization must position its machinery and other equipment so as to achieve smooth flow of products through their factories. A good layout results in comforts convenience, safety, efficiency, Compactness and profits. A poor layout results in congestion, waste, frustration and inefficiency. Thus after plant location the proper design of plant layout is most significant for smooth functioning and success of the organization. Plant Layout Tools and Techniques I. Process charts i. ii. Operations Process Charts Flow process Chart
II. Process Flow Diagrams III. Machine data cards IV. Visualization of Layout i. ii. Two-dimensional plan or Templates Three-dimensional Plan or machine models
Plant Location The performance of an enterprise is considerably affected by its location. The location of an industry is as important as the choice is for the location of a business or a shop in a city or locality. Unscientific and unplanned industrialization is harmful not only to the industrial unit but also to the social and economic structure of the country as a whole. Nearly sixty years before, much importance was not given to the selection of appropriate location and the decisions in this regard were mainly governed by the individual preferences of the entrepreneurs and
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social customs. This resulted in failure of any organization which otherwise could have been successful. Government also with the objective of establishing socialistic pattern of society became instrument all in the selection of site for various industries in undeveloped areas by providing various investment benefits and other incentives. All this encouraged a large number of industrialists to follow a more scientific a logical approach towards the selection of site for establishing their industries. The degree of significance for the selection of location for any enterprise mainly depends on its size and nature. Sometimes, the nature of the product itself suggests some suitable location. A small scale industry mainly selects the site where in accordance with its capacity the local market for the product is available. It can easily shift to other place when there is any change in the market. But for large scales industries requiring huge amount of investment there are many considerations other than the local demand in to the selection of proper plant location. These plants cannot be easily shifted to other place and an error of judgment in the selection of site can be very expensive to the organization. Production Methods One activity of the administrative side of production is concerned with finding and stating the one best way to do all jobs. No longer is this left to the skilled and interested operator, proceeding by trial and error, successive operators making the same, or sometimes a different result. As more machines, tools and equipment, some of them highly specialized, have been designed and become available, and new materials and process materials and process developed, it has become increasingly a skilled technical job to keep abreast of developments and always to know the up-to-date or best way to do a job. It would be quite impossible today for the craftsman at the bench or machine to keep him so informed and do a job of producing. Skilled men are still required, but increasingly today they become setters, minders, or maintenance men. The old type of foreman is apt to think that the appointment of a production engineer, process engineer, or chemist, reduces his usefulness, his value to the Company, or his status. It does nothing of the kind, of course. It is true that, before the development of production engineering, and the use of chemists in the works as well as in the analytical laboratory, the Work Manger and his foreman supplied the production know-how, and decided how a job should be done. But it is now recognized that the training and supervising of person is a much more complex job than it once was, and to relive a foreman of a large amount of administrative work makes a higher general performance possible and his job more valuable, not less. It is essential to separate planning form doing, administration from execution. When a new material is developed or a new product designed, the method of production is obviously either known or worked out. But form then onwards all is change. Better method of production is being discovered continually. Furthermore, in many factories, particularly those engaged in engineering, the detailed method of production for each part to be manufactured, the machines to be used and equipment required, is decided subsequent to design. The task of deciding the best method of production, of saying how a job shall be produced, and of finding new and better ways of doing so, should be the responsibility of a Method of Production Engineering Department. Similarly, in a company where the
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technical knowledge is supplied by chemists, production method would be the responsibility of the works laboratory. In deciding the one best way of doing a job, the production engineer or chemist must have regard for the costs of production, and therefore for the time to do the job. He must have regard for the costs of production, and therefore for the time to do the job. He must have some say also in new tools or equipment required. These are the three divisions into which the activities of the production or methods engineer usually fall that is to say, work study or methods, work measurement or time study and tool design. These three aspects all call for close collaboration with the designer and works departments. The design of jigs and tools might be thought to be a logical development of the Design or Drawing Office work and in some works it is done in the Drawing Office. But it cannot be effectively developed without detailed study of methods and work being done in the factory, and, as will be shown later, this study forms the basis of standards for time, and hence for payment by results, production planning and costs. This study work calls for a specialized technique and training quite different form Drawing Office work. The outlook required is different too. It is more successful in practice if it is recognized as a separate activity, and combined with the design of tools and equipment. To avoid it becoming too remote from or independent of the Drawing Office, Design Department, or Technical Department, new drawings, designs, or technical developments should always be referred to, and discussed with, the production engineers before final issue. The development of production engineering as a special skill and the extensive use of specially designed tools and equipment have contributed largely to the very much greater output per man-hour. There is no doubt that it is through such development, adding horse-power to man-power, and taking out the manual efforts from jobs, that the way lies to reduce man-hour requirements. Because production engineers tend to get machine or gadget minded, they are apt to forget or neglect the human factor. Machines cannot yet operate without human agency, and men should not be made into robots. The foremen may have something to say if the division of labour, for example, is carried too far, or if new methods are forced on them without consultant. Continued and close co-operation between the production engineers and works departments is absolutely essential. The function of the production Engineering or Methods Department is to determine, in collaboration with the Design and Works Departments, the most effective, economical and suitable method of production, today down standards for material and time, and to design special tools and equipment required. Production Planning Planning may be defined as Any information which either specifies or guides the taking of future actions by its members geared towards overcoming existing or anticipated problems. Billy E. Goetz has rightly remarked planning as fundamentally choosing, and a planning problem arises when an
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alternative course of action is discovered. So, in simplest way, we may define production planning as planning of production. But production planning requires a careful and elaborate study of co-ordinating and related activities which are necessarily performed by different departments. Messrs. Bethol, Smith and others in their book Industrial Organization and Management have defined the production planning as It is a series of related and co-ordinated activities performed by not one but a number of different departmental groups, each activity being designed to systematize in advance the manufacturing efforts in its area. Conclusively, production planning may be defined in the words that It is the predetermination of manufacturing requirements such as available materials, money men, order, priority, production process etc. within the scope of Industrial unit for efficient production of goods to cope with its sale requirements. Production planning mainly depends on the type of manufacturing plants which can be divided into two categories: (a) Continuous type of manufacturing plants such as rayon, yarn, shoes, paper plants etc. and (b) Intermitted type of manufacturing plants such as Engineering type of plants and also repetitive type of industries-automobiles, typewriters etc. Planning in the continuous type of plant is somewhat easy as we have only to decide what and when and not to decide how and where. In intermittent type of plant. Planning becomes difficult by the entry of a number of complex factors into picture. The same machine is engaged for production of different parts at different times, the machine is kept busy to meet the requirements for various parts to the customers best satisfaction. In the repetitive type of plant such as automobiles the process appears to be continuous but we have depend on so many parts meeting the schedule before we can move on to the next; thus planning becomes complex. For example, in an automobile plant, a sub-assembly process cannot be said to be complete unless all the various parts whether manufactured on the plant or sub-contracted form outside are available as complete.
5.7 Organization of Human Resources in MNCs

The organizational activities undertaken by a Human Resources Department of International organization to effectively utilize its Human Resources. Staffing Selection Management development
The roles of the managers in transnational corporations are categorized as given below: Top-level corporate management Global business managers
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Worldwide functional managers Country (subsidiary) managers
The role of the Global business managers are having the following functions Cross-border coordination Need not to be located in the home country Worldwide product strategist Asset and resource configuration
Worldwide functional managers and their role in Human Resources Management Cross-pollinator of best practices Developing and diffusing knowledge specialized by function tech, marketing, manufacturing, etc. Worldwide intelligence scanner
The roles of country managers are discussed as given below: Frontline implementer of corporate strategy Bicultural interpreter National defender and advocate (ensuring the needs and opportunities that exist in the local environment are well understood and incorporated into the decision-making process).
Top-level corporate management has the following functions Ensuring continual renewal Reducing internal bureaucracy, forcing adaptation and learning, etc. Providing purpose and direction Facilitating cross-organizational flows (resources, goods, and information).
Staffing country managers are play a vital role and has the following role Geocentric approach Staffing policy - the selection of employees who have the skills required to perform a particular job.
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Types of approach of staffing in International Human Resources 1. 2. Ethnocentric approach Polycentric approach
Factors associated with employee willingness of the international organization to take expat assignments Organization relocation support activities Career planning support, selection practices, lead time, training support, mentor support, compensation, family assistance, repatriation support
Employee personal characteristics in International Human Resources Age, sex, marital status and children, international experience Employee job and relocation attitudes International interests, ethnocentrism, career focus, , organizational commitment, readiness for relocation Spouse characteristics and attitudes Spouse employment status
5.8 International Finance Management

The Management of finances is a very important operation in the affairs of any organization. Whether it is involved in domestic business or international business. But the financial management aspect is more complex or complicated in the case of international business as compared to domestic business on account of the differences in currencies; differences in tax policies; differences in economic and political conditions; differences in movement of and restrictions on capital; foreign exchange risk; etc. which accompany the former. Thus, international financial management requires a thorough understanding of these factors and their effective management for the organizations benefits. In brief, we can define international financial management as the process that encompasses the following activities. The investment decision, the financing decisions, the management of global cash flows and the management of foreign exchange risk. The organization involved in international business can gain a competitive edge by managing their International finances effectively and efficiently. For example, certain organization reduced their cost of raising capital, in 2001 by issuing foreign bonds in Japan instead of U.S.A. as the interest rates were low in Japan, so debt was available at a cheaper rate or FMC, a Chicago based producer of chemicals and farm equipment which generates 40 percent of its sales outside the home nation, offers its customers stable long term prices for three or more years and provide them the option of paying in several currencies as per their convenience.
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Investment Decisions A very important decision which organization involved in international business must take is what projects are to be financed? and in which national these are to be financed. These questions which relate to the investment decisions are of prime importance from the perspective of parent organization. If answered wrongly then they could create perennial problems for the organization or could lead to heavy losses or could result in complete failure. On the other hand, if these are answered correctly, then they could lead to increase in profits for the parent organization or increase in market share of the organization or could provide a source of competitive edge to the organization. In order to decide about where to invest and where not to invest, organization looks at a large numbers of factors like the socio-cultural, economic, political, legal natural and demographic environment of the host nation. Capital Budgeting The top management of the organization can take a decision about the investment only when it has a definite idea about the benefits, costs and risks associated with it. Capital budgeting is a technique which quantifies the benefits, costs and risks involved with an investment or a project. Thus capital budgeting allows the top management to easily compare different projects in different nations and make informed choices about where to make the investment. In carrying out capital budgeting the organization involved in international business uses the same theoretical framework as used by an organization involved in domestic business i.e. the organization makes use of concepts like cash inflows, cash outflows, discount rate, etc. In order to find out the Net Present Value of the project. If the NPV comes out to be greater than zero, then the organization can go for the project. In spite of the fact that certain similarities exist between the capital budgeting technique followed by an organization involved in international business and the technique followed by an organization involved in the domestic business, there are certain dissimilarities also. Some of the aspects of capital budgeting which are specific to foreign project assessment are: The cash flows occurring from the project must be analyzed from the perspective of the parent organization. The cash flows occurring to the project are not necessarily the cash flows that will occur to the parent organization. It is often seen that because of the policies, rules and regulations of the host nation it is not always possible to remit all the cash flows, which are generated from the project, to the parent organization in the home nation. The political risk which refers to the change in the political environment of the host nation that adversely affects organizations goals can substantially reduce the value or expected cash flows of the project. The political risk tends to be more in case of the nations where the government is autocratic, which are passing through a period of social unrest and which are less developed.
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The economic risk associated with the foreign investments are more than the domestic investments, and mainly relate to increase in the inflation rate in the host nation, depreciation in the value of the local currency or erratic fluctuations in the exchange rate of the host nation currency. All these developments or developments in any of these could drastically affect the cash flows that occur to present organization. Financing Decisions Once the organization is able to decide about the foreign project which it will be taking for investment, the next question which arises for it is how to finance the investment? That is the organization has to decide about the source of financing and the structure of financing. In source or external sources for generating the required funds. In structure of financing the organization has to decide about the mix of debt and equity, which it will be using for financing the project. Source of Financing As far as the sources of financing are concerned, the organization has to decide that whether it will be using internal sources for financing the project or external sources or a combination or the two. If the organization decides to make use of the internal sources for financing a new project in the host nation, then it has the following options; If a subsidiary in the host nation is responsible for the new project then it could make use of the funds which it gets by selling the product or by providing the service in the host nation. The subsidiary can get the funds from the parent organization. The subsidiary can also get the required funds from some other subsidiary in the same nation or from some other nation. Financial Structure The financial structure adopted by an organization for financing an investment varies from nation to nation and organization and organization. That is there is no standard format available regarding the amount of debt and equity which should be used for financing the projects in all situations across nations, worldwide.

1. 2. 3. 4. 5. What is International Strategic Management? Explain the process of International Strategic Management? What is Global Competitive Advantage? Explain Global Marketing and its advantages and disadvantages? Explain International Finance Management and its functions. ****

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Module I FOUNDATION OF INTERNATIONAL BUSINESS

1.0 Learning Outcomes

MBA - IV Semester - International Business

1.2 Origin of International Business

Module 1 - Foundation of Inetrnational Business

1.2.1 International Trade

MBA - IV Semester - International Business

1.2.2 Features of International Trade

Module 1 - Foundation of Inetrnational Business

1.2.3 Importance of International Trade

MBA - IV Semester - International Business

1.2.4 Current Trends in International Trade

1.2.5 Growth in Merchandise Trade

1.2.6 Commodity composition of Trade

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

Module 1 - Foundation of Inetrnational Business

10 1.3 International Marketing

MBA - IV Semester - International Business

Module 1 - Foundation of Inetrnational Business

Figure 1: International Business Model

MBA - IV Semester - International Business

1.4 Multinational Enterprises

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

1.5 International Trade Theories

Module 1 - Foundation of Inetrnational Business

Product Life Cycle Theory Porters Diamond Model

1.5.1 Theory of Mercantilism

MBA - IV Semester - International Business

1.5.2 Theory of Absolute Advantage

Module 1 - Foundation of Inetrnational Business

1.5.3 Theory of Absolute Cost Advantage

1.5.4 Theory of Comparative Advantage

MBA - IV Semester - International Business

1.5.5 Theory of Comparative Cost Advantage

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

1.6 The Product Life Cycle Theory

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

Module 1 - Foundation of Inetrnational Business

MBA - IV Semester - International Business

1.7 Review Questions

Module II PLANNING AND ORGANISING THE HRD SYSTEM

2.0 Learning Outcomes

2.1 Foreign Direct Investment (FDI)

MBA - IV Semester - International Business

Module II - Planning and Organising the BRD System

MBA - IV Semester - International Business

Module II - Planning and Organising the BRD System

MBA - IV Semester - International Business