International business environment lesson 05

55 World Financial Environment UNIT UNIT III 56 International Business Environment 57 World Financial Environment LESSON WORLD FINANCIAL ENVIRONMENT CONTENTS 5.0 Aims and Objectives 5.1 Introduction 5.2 Globalisation 5.3 5.2.1 Features of Globalisation 5.2.2 Stages of Globalisation 5.2.3 Globalisation of Markets, Production, Investment and Technology Working of Foreign Exchange Markets 5.3.1 Foreign Exchange Market 5.3.2 Functions of Foreign Exchange Market 5.4 Let us Sum up 5.5 Lesson End Activity 5.6 Keywords 5.7 Questions for Discussion 5.8 Suggested Readings 5.0 AIMS AND OBJECTIVES After studying this lesson, you should be able to: • Know the financial environment • Study the functions of foreign exchange markets • Know the working foreign exchange markets 5.1 INTRODUCTION The medieval proverb says ‘merchant has no nations.’ It means that a businessman can view the entire world as one country for his operations In fact, businessmen were doing their operations even before Christ Even Hindu epics like, Ramayan and Mahabarat indicate that business operations used to exist across countries even in those days Therefore, the concept of global business is as old as civilizations The concept of global business gradually encompassed into globalization with the addition of a few more wings to it The entire globe is just like on country for business Erasing national and political boundaries for the purpose of business may be termed as globalization Globalization 58 International Business Environment implies integration of the economy of the country with the rest of the world economy and opening up of the economy for foreign direct investment by liberalizing the rules and regulation and by creating favorable socio-economic and political climate for global business Having the general idea, we now discuss the meaning and definition of globalization 5.2 GLOBALISATION International Monetary fund defines globalization as, “the growing economic interdependence of countries world wide though increasing volume and variety of cross border transactions in goods and services and of international capital flows and also through the more rapid and widespread diffusion of technology.” Charles U.L Hill defines globalizations as, “the shift towards a more integrated and interdependent world economy Globalization has tow main components – the globalization of markets and the globalization of production.” Interdependency and integration of individual countries of the world may be called as globalization Thus globalization integrates not only economies but also societies The globalization process includes globalization of markets, globalization of production, globalization of technology and globalization of investment 5.2.1 Features of Globalisation Globalization encompasses the following features: z Operating and planning to expand business throughout the world z Erasing the differences between domestic market and foreign market z Establishing manufacturing and distribution facilities in any part of the world based on the feasibility and viability rather than national consideration z Product planning and development are based on market consideration of the entire world z Sourcing of factors of production and inputs like raw materials, machinery, finance, technology, human resources, managerial skills from the entire globe z Global orientation in strategies, organizational structure, organizational culture and managerial expertise z Setting the mind and attitude to view the entire globe and a single market Global companies plan or venture not only on national markets, but also venture globally and view themselves as a global company Executives and employees of such companies are trained and tuned in world-wide operations For example, employees in a global company based in India speak of London, New York, Mumbai, Tokyo, Singapore, Asmara and the like, as Indian businessmen speak of Delhi, Hyderabad, Ahmedabad, Mumbai, Chennai, Kolkata and the like They make investments based on the feasibility of world-wide projects, and procure raw materials, human resources and other inputs from all points of the world where they available at low cost and high quality Kenichi Ohamae observes that global companies develop a genuine equidistance of perspective These companies view all the stakeholders from all countries equally for their operations The examples include Coca-Cola, Honda, P&G, Toyota, Xerox, Mazda, Dr.Reddy’s lab, Reliance etc for example, Mazda’s sports car MX-5 Maita was designed in California, its Prototype product is created in England, assembled in Michigan and Mexico using advanced electronic components which are invented in New Jersey, fabricated in Japan by sourcing the finance from Tokyo and New York and marketed world-wide 5.2.2 Stages of Globalisation 59 World Financial Environment Now, we discuss how the globalization process takes place Globalisation Process Globalization does not take place in a single instance It takes place gradually through an evolutionary approach According to Ohamae, globalization has five stages They are, Domestic company exports to foreign countries through the dealers or distributors of the home country In the second stage, the domestic company exports to foreign countries directly on its own In the third stage, the domestic company becomes an international company by establishing production and marketing operations in various key foreign countries In the fourth stage, the company replicates a foreign company in the foreign country by having all the facilities including R&D, full-fledged human resources etc In the fifth stage, the company becomes a true foreign company by serving the needs of foreign customers just like the host country’s company serves Thus, globalisation means globalising the marketing, production, investment, technology and other activities Now we shall discuss each of these aspects, in detail 5.2.3 Globalisation of Markets, Production, Investment and Technology Globalization is the trend toward a more integrated global economic system In figure shows the components of globalization The components of globalization are: globalization of markets, globalization of production, globalization of investment and globalization of technology First, we discuss the globalization of markets Components of Globalization Globalization of Globalization of Markets Production Globalization of Investment Globalization of Technology Figure 5.1 Globalization of Markets Globalization of markets refers to the process of integrating and merging of the distinct world markets into a single market This process involves the identification of some common norm, value, taste, preference and convenience and slowly enable the cultural shift towards the use of a common product or service A number of consumer products have global acceptance For example, Coca-Cola, Pepsi, McDonald’s burgers, Music of Madonna, MTV, Sony Walkmans, Levis jeans, Indian masala dosa, Indian Hyderabad biryani, Citicorp credit cards etc Features of globalization of markets include: z The size of the company need not be too large to create a global market Even small companies can also create a global market For example, Harry Ramsden- a 60 International Business Environment small British company with an annual sale of US $ 16 million is trying to sell its product of fish ‘n’ chips in Japan based on the Japanese culture z The distinctions of national markets are still prevailing even after the globalization of markets These distinctions require the companies to formulate different strategies for each market For example, Coca-cola, Levis jeans and McDonald employ separate strategies for each country z Most of the foreign markets are the markets for non-consumer goods like industrial products, machinery, equipment, raw materials, computers, software, financial products etc z The global business firms compete with each other frequently in different national markets including their home markets For example, Coca-Cole is the global rival of Pepsi Similarly Ford and Toyota, Boeing and Airbus, Caterpillar and Komatsu Though these companies compete with each other they create a global market Reasons for globalisation of markets include: z Large-scale industrialisation enabled mass production Consequently, the companies found that the size of the domestic market is very small to suffice the production output and thus opted for foreign markets z Companies in order to reduce the risk diversify the portfolio of countries z Companies globalize markets in order to increase their profits and achieve companies to globalize their markets z To cater to the demand for their products in the foreign markets z To failure of the domestic companies in catering the needs of their customer pulled the foreign countries to market their products Globalization of Production Factors influencing the location of manufacturing facilities vary from country to country They may be more favorable in foreign countries rather than in the home country For example, cheap labor in developing countries, availability of high quality and cheap raw material in other countries etc., enable the companies to produce the products of high quality and low cost in various foreign countries Companies globalize the production facilities due to the flowing reasons: z Imposition of restrictions on imports by the foreign countries forces the MNCs to establish the manufacturing facilities in other countries For example, Toyota of Japan established its plants in USA and UK due to the import restrictions z Availability of high quality raw materials and components in other countries z Availability of inputs at low cost in foreign countries z Availability of skilled human resources at low cost z Liberal labor laws in the foreign countries z To reduce the cost of transportation and easy logistics management z Facility of exporting to other neighboring foreign countries z To design and produce the products as per the varying taste of customers in foreign countries Therefore, the companies tend to produce in different locations of the world in order to enhance the quality, reduce the cost of production, cost of transportation and delivery time to the various markets Thus, the globalization of production is locating the manufacturing facilities in a number of locations around the globe to take the advantages of national differences in cost, quality and availability of inputs and of reaching various markets at the shortest possible span of time The process of globalization of production of production helps the companies to design the following strategies: z Low cost leadership z Superior quality and z Superior speed For example, Jet airlines – Boeing 777 has 132,500 major components These components are produced in 545 different locations of the globe A small optical company in USA, i.e., Swan Optical, manufactures its eyewear in low cost factories in Hong Kong, China, Japan, France and Italy In addition to the globalization of markets and production, a number of factors enable the process of globalization at a fast rate Now, shall discuss the investment factor Globalization of Investment Many countries, before 1930s, created barriers relating to exports, imports and foreign investment The creation of General Agreement pm Tariffs and Trade (GATT) reduced the trade restrictions significantly Further, the establishment of World Trade Organization has contributed for the elimination of investment barriers phenomenally Many countries reduced investment barriers As many as 34 countries made 85 changes to their laws, reducing investment barriers in 1991 alone Government of India reduced the barriers on investment allowing more than 51 per cent of foreign investment in Indian companies Globalization of investment refers to investment of capital by a global company in any part of the world Global company conducts the financial feasibility of the new projects, in different countries of the world and invests the capital in that country where it is relatively more profitable Globalization of investment is also known as Foreign Direct Investment Foreign Direct Investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market a product or service in a foreign country Coca-Cola acquired a number of bottling companies throughout India by investing the capital directly It directly invests the capital in a number of countries The reasons for the increase in the global investment include: z There has been a rapid increase in the volume of global trade Many countries provided more congenial environment for attracting direct investment For example, government of India provided for automatic approval for FDI up to 51% of capital of a company It extended this up to 100% for the cigarette industry z Significant amount of FDI is directed to the developing countries in Asia and Eastern Europe z Small and medium size companies have started investing in various countries z In addition to increase in the volume of FDI, its composition has also been changing Initially FDI was directed mostly towards USA FDI, recently has been directed towards other countries like UK, Japan, France, China etc z With the recent globalization process, FDI has been directed even towards the developing countries 61 World Financial Environment 62 International Business Environment z Limitations of exporting and licensing force the domestic companies to enter foreign markets through FDI z Global companies in order to have the control over manufacturing and marketing activities, invest in the foreign countries z Liberalizing the measures of flow of foreign capital across the borders by various countries For example, Indian Government allowed Foreign Institutional Investors (FIIs) to invest in Indian capital markets after registration with the SEBI z International firms go for FDI in order to avoid the restriction imposed by the host country on exports For example, Toyota, a Japanese automobile company increased its investment in USA, UK and other countries consequent upon the imposition of restriction on exports of automobiles by the host countries Sourcing Funds Globally The other factor, which contributes for the increase in global investment, is the sourcing of funds globally In other world, procuring investment internationally Most of the MNCs procure funds from any source in the globe, wherever the cost of capital is low with feasible terms and conditions The liberalization announced by the Indian Government allowed the Indian companies to procure capital from other countries by issuing equity, debentures, bonds, euro issues, Global Deposit Receipts (GDRs) etc fro example, Reliance, Dr Reddy’s Laboratory, Satyam computer etc., procured investment from USA and European counties Important sources of capital from the globe include: z International Bank for Reconstruction and Development, IBRD provides capital to public and private sector companies of member countries z International Finance Corporation (IFC) provides loans at very low rate of interest and at liberalized terms and conditions even to the private sector companies Hence, it is also known as ‘soft loan window’ z International Development Association Provides loans at liberalized conditions to the private sector companies of their developing countries z Asian Development Bank, African development Banks etc., also provides loans to the private sector companies of their respective member countries z Mutual Funds of various countries also invest in companies based in foreign countries z Investors have also started investing in shares of foreign companies Modes of Globalisation of Investment Modes of globalization of investment include: z Acquisition of foreign companies z Joint Ventures z Long-term loans z Issuing Equity Shares, Debentures, Bonds z Global Deposit Receipts etc The measures of economic liberalization and globalization of their economies announced by a number of countries contributed for the increased growth rate of globalization of inve Check Your Progress 1 Define globalization …………………………………………………………………………… …………………………………………………………………………… What are the modes of globalisation of investment? …………………………………………………………………………… …………………………………………………………………………… 5.3 WORKING OF FOREIGN EXCHANGE MARKETS 5.3.1 Foreign Exchange Market The subject of foreign exchange is, in the words of H.E Evitt, “the section of economic science which deals with the means and methods by which rights to wealth in one country’s currency are converted into rights to wealth in terms of another country’s currency As the further observes, it “involves the investigation of the method by which the currency of one country is exchanged for that of another, the causes which render such exchange necessary, the forms which such exchange may take, and the ratios or equivalent values at which such exchanges are effected.” There are different interpretations of the term foreign exchange, of which the following two are most important and common: Foreign exchange is the system or process of converting on national currency into another, and of transferring money from one country to another (Dr Paul Einzing) Secondly, the term foreign exchange is used to refer to foreign currencies For example, the Foreign Exchange Regulation Act, 1973 (FERA) defines foreign exchange as foreign currency and includes all deposits, credits and balance payable in any foreign currency and any drafts, traveler’s cheques, letters of credits and bills of exchange, expressed or drawn in Indian currency, but payable in any foreign currency 5.3.2 Functions of Foreign Exchange Market The foreign exchange market is a market in which foreign exchange transactions take place In other words, it is a market in which national currencies are bought and sold against one another A foreign exchange market performs three important functions: Transfer of Purchasing Power The primary function of a foreign exchange market is the transfer of purchasing power from one country to another and from one currency to another The international clearing function performed by foreign exchange markets plays a very important role in facilitating international trade and capital movements Provision of Credit The credit function performed by foreign exchange markets also plays a very important role in the growth of foreign trade, for international trade depends to a great extent on credit facilities Exporters may get pre-shipment and post-shipment credit Credit facilities are available also for importers The Euro-dollar market has emerged as a major international credit market 63 World Financial Environment 64 International Business Environment Providing Hedging Facilities The other important function of the foreign exchange market is to provide hedging facilities Hedging refers to veering of export risk, and it provides a mechanism to exporters and importers to guard themselves against losses arising from fluctuations in exchange rates Check Your Progress Fill in the blanks: Globalization of investment refers to by a global company in any part of the world The Euro-dollar market has emerged as a _ The primary function of a foreign exchange market is the transfer of from one country to another and from one currency to another 5.4 LET US SUM UP Globalisation of investment refers to investment of capital by a global company in any part of the world Global company conducts the financial feasibility of the new projects in different countries of the world and invest the capital in that country where it is relatively more profitable Globalisation of investment is also known as Foreign Direct Investment Foreign Direct Investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market a product or service in a foreign country Coca-Cola acquired a number of bottling companies throughout India by investing the capital directly It directly invests the capital in a number of countries 5.5 LESSON END ACTIVITY Prepare a study note on the world financial environment 5.6 KEYWORDS International Bank for Reconstruction and Development, IBRD: It provides capital to public and private sector companies of member countries International Finance Corporation (IFC): It provides loans at very low rate of interest and at liberalized terms and conditions even to the private sector companies Hence, it is also known as ‘soft loan window’ International Development Association: It provides loans at liberalized conditions to the private sector companies of their developing countries Asian Development Bank, African development Banks: It provide loans to the private sector companies of their respective member countries 5.7 QUESTIONS FOR DISCUSSION What are the different modes of globalization of investment? Explain the working of foreign exchange markets What are the functions of foreign exchange markets? Check Your Progress: Model Answers CYP 1 Definition of Globalisation: International Monetary fund defines globalization as, “the growing economic interdependence of countries world wide though increasing volume and variety of cross border transactions in goods and services and of international capital flows and also through the more rapid and widespread diffusion of technology” Modes o Globalisation of Investment: Modes of globalisation of investment include: a) Acquisition of foreign companies b) Joint Ventures c) Long-term loans d) Issuing Equity Shares, Debentures, Bonds e) Global Deposit Receipts etc CYP investment of capital Major international credit market purchasing power 5.8 SUGGESTED READINGS Daniels, D and Radebangh H., “International Business”, Pearson Education Asia, New Delhi, 2002 Griffin and Pustay, “International Business”, Pearson Education Asia, New Delhi, 2002 Subba Rao, “International Business”, Himalaya, Mumbai, 2001 Schaffer, “International Business Law and its Environment”, Thomson, 2002 Onkwist and Shaw, “International Marketing” Philip R Careora, “International Marketing” 65 World Financial Environment ...56 International Business Environment 57 World Financial Environment LESSON WORLD FINANCIAL ENVIRONMENT CONTENTS 5.0 Aims and Objectives 5.1 Introduction... Pustay, ? ?International Business? ??, Pearson Education Asia, New Delhi, 2002 Subba Rao, ? ?International Business? ??, Himalaya, Mumbai, 2001 Schaffer, ? ?International Business Law and its Environment? ??, Thomson,... importers The Euro-dollar market has emerged as a major international credit market 63 World Financial Environment 64 International Business Environment Providing Hedging Facilities The other important