factor flows and foreign exchange issues

Factor flows and foreign exchange issues

25-06-2015 1Rojers P Joseph - IIM Rohtak

Case

Between 2003 and 2004, as the US dollar continued to weaken

against both the Euro and Yen, why did the Japanese central

bank spent 30 trillion yen to buy dollars?

Dollar alone was falling Dollar alone was falling


US trade in goods with Japan

Year Exports ImportsBalance of

trade

All figures in Millions of USD

2004 53,568.7 129,805.2 -76,236.5

2003 52,004.3 118,036.6 -66,032.4

Source: US Census Bureau25-06-2015 3Rojers P Joseph - IIM Rohtak

Question

Was the Japanese approach fundamentally correct?

e.g. South Korea (from 2002-2005, won appreciated 30% against the

dollar)

Correct the economic fundamentals


Session objectives

Understand how governments control the flow of currencies

across national borders

Examine the roles of different institutions in foreign exchange

Understand how exchange-rate movements influence

business decisions


Case

The rupee had a free fall in 2013 when it lost over 19% against

the dollar. What possible measures could the Reserve

Bank/Government of India have adopted in arresting the fall?

Sell forex reserves to buy rupees Sell forex reserves to buy rupees

Let a foreign country to buy rupees

Raise interest rates

Restrict the outward flow of Indian rupees


What did the Government/RBI do?

Raised interest rates

Restrict the outward flow of Indian rupee Restriction on Indian firms investing abroad

Restriction on remittances by resident Indians Restriction on remittances by resident Indians

Tariffs on import of gold


Did RBI succeed?

Worsening current account deficit (CAD) Trade deficit: $185 billion

Insufficient FDI inflows

Large FII outflows Large FII outflows

Rising import bill

Lower GDP growth rate

Strengthening of dollar

Eventually, how did rupee appreciate significantly in 2014, after almost a year?


Balance of payments

The current account and the capital account together

constitute a nation's balance of payments


The current account

Balance of trade: Export and import

Net earnings from investments: interest and dividend

Net cash transfers: Remittances, gifts and other unilateral

transfers


The capital account

The capital account:

Net Foreign direct investment (FDI): Long-term capital investment

Net Portfolio investments: Purchase or sale of shares and bonds

Other net investments: Loans, Capital flow into bank accounts

Net changes in the reserve account: Operated by the Central Bank to Net changes in the reserve account: Operated by the Central Bank to

buy and sell foreign currencies


Payment/receipt in Capital/Current account?

(1) A German investors purchase of shares of TCS stock

(2) $5 million of foreign aid to Fiji

(3) An Indians purchase of an airline ticket from British

Airways

(4) A loan by an Indian bank to Kenya(4) A loan by an Indian bank to Kenya

(5) A Chineses purchase of Darjeeling Tea

(6) An Indian banks borrowing of dollars


Daewoo and Asian Financial Crisis


Precursor: the East Asian miracle

Asian Tigers: highly developed economies of Hong Kong, Singapore, South Korea and Taiwan

Exceptionally high growth rates (double digits) and rapid industrialization between the early 1960s and 1990s (NICs)

Highly educated and skilled workforce

Specialized in areas where they had a competitive advantage

Non-democratic and relatively authoritarian political systems during the early years


The Asian financial crisis?

July 1997: Depreciation of the Thai Baht

Crisis spread to S. Korea, Indonesia, Malaysia and the

Philippines

Singapore, Hong Kong and Taiwan were also affected

1998: crisis spread to Russia 1998: crisis spread to Russia

complete financial, economic and political collapse

Spread to Latin America, particularly Brazil

Brazil survived with IMF funding

1999: situation improved

2000: complete recovery


Source: IMF, World Economic Outlook (October 1999) 25-06-2015 16Rojers P Joseph - IIM Rohtak

Core Issue

Financial crisis: Financial institutions or assets lose a large part

of their value

Debt burden

Depreciation of currency

Macro-economic policy induced crisis


Questions

1. How would you describe Koreas economic system? What

are the key elements in that system? How would you describe

the interaction between politics and economics in Korea?

2. What were the key mistakes Kim Woo-Choong made in

formulating and implementing Daewoos strategy, and how

did the economic crisis in Korea and in the rest of Asia affect did the economic crisis in Korea and in the rest of Asia affect

that strategy?

3. Does Korea look like a good place to invest? Why or why

not?

4. What risks does GM face in taking over Daewoo Motors?

How can GM overcome them?


Questions

How would you describe Koreas economic system? What are

the key elements in that system? How would you describe the

interaction between politics and economics in Korea?

Chaebols

Family owned businesses

Governments objective: export orientation Governments objective: export orientation

(Refer to the 3rd era in the evolution of international trade and investment)

Loans and other special favours

Strong cooperation between the state and the private sector

Charges of corruption

Concentration of economic power in a few


The Korean economy prior to the crisis

Government: huge debt burden

External debt vs. internal debt

Firms as well as countrys

Banks: technically insolvent

Borrowed money in dollar terms Borrowed money in dollar terms

Preponderance of short-term finances in the capital structure

Bad loans

Chaebol: high rate of capital accumulation

Overextended Chaebols (vis--vis the fourth era of international trade

and investment)

large capital inflows and foreign investment in 1990s

Worsening D/E ratio

Led to excessive exposure to foreign exchange risk25-06-2015 21Rojers P Joseph - IIM Rohtak

Forex reserves

Most of these countries had low forex reserves

The usable foreign exchange reserves of S. Korea had come down to

about $7 billion (of the value of 2 weeks imports) in November 1997


In million dollars


Summary

Weak regulatory framework in the Korean financial and

economic system

Internal economic and financial mismanagement and excesses

India and China were less affected by the crisis


All values in millions of dollars


Questions

Does Korea look like a good place to invest? Why or why not?

Not with

Devalued currency

Huge debts

Faltering financial institutions Faltering financial institutions

Yes with the IMFs conditions

Banking reforms

Bankruptcy laws


Questions

What are the key mistakes Kim Woo-Choong made in

formulating and implementing Daewoos strategy, and how

did the economic crisis in Korea and in the rest of Asia affect

that strategy?

Continued with the expansion plans Continued with the expansion plans

Added more debt

Issued corporate bonds

Could not service interest payments

Requested a moratorium on interest payments

Instability spread to international markets


Questions

What risks does GM face in taking over Daewoo motors? How

can GM overcome them?

Financial risks?

Debt burden

The governments mandate on D/E ratio

Marketing risks? Marketing risks?

Competing brands

Restoring market share


The role of IMF

The rescue package organised by the IMF: $58 billion

$21 billion was the loan pledged by the IMF (the largest amount to be

lent to any country in a single deal till then)

The rest of the $58 billion included loans from the World Bank, the

Asian Development Bank and the Japanese government


Why was India not affected by the crisis?

Full Capital Convertibility was not allowed.

Lock in Period for foreign investment in real estate.

Floating exchange rate with some influence by the RBI during Floating exchange rate with some influence by the RBI during

periods of crisis (Managed float).

Strong Fundamental growth with services sector being the prime

reason.

External Debt to GDP has been declining for the past few years.


factor flows and foreign exchange issues

Documents

reserve account

net investments

capitalcurrent account

capital flow

net earnings

bank accounts net changes

outward flow of indian

us dollar