if - intro

7/27/2019 IF - Intro

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International Finance

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1. Introduction – International Finance, International Monetary System,International Trade and Finance

2. Trade Theories

3. Dynamics of International Trade

4. Balance of Payment, Commercial Policy

5. Exchange Management

6. International Marketing

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7. Trade Practice and Procedures

8. Forex Markets

9. Foreign Aid and Term Lending

10. FX Risk Management

11. Swaps / Derivatives

12. Present FX scenario in India

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Introduction to I F• Why to stud

y International Finance and its management

– Economic and Financial Reforms 1991

– The world of Interdependence – DF and IF are complementary and

competitive

– Growing network of Transport and Communication

– Factors influencing operations and systems of DF and IF are different

– Study must for certain Specific industries such as Shipping , Airways,

Tourism, Banking and Financial services etc.

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Introduction to I F• Input Marke

t: -

– Physical Inputs - Equipments, P&M, Raw Material, Spare Partsi,

intermediates etc.

– Financial Inputs - Project outlays, wages, labour , cost of Patents,

Royalties etc.

– Subsidiaries / Branches of Foreign companies etc. – Capital, financial

support

• Output Market: -

• Sale of final and intermediate products, Services offered

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Introduction to I F• International Financial markets emerged out of the need to facilitate

operations of nations with the rest of the world, arising out of the

commercial and financial transactions. This emergence can be attributed

logically to –

• a) Sectoral interdependence – Corporate sector (part of Business sector)

with Government Sector, Household sector and Foreign sector

• B) National Interdependence – Due to a) Different production function, b)

Different stages of growth of industry, agri and other sectors, c) Different

levels of savings and Investment, d) Differentials in technologicaladvancement, e) Difference in standards of livings and income, e)

Different tastes and consumer preferences, f) Differences in culture etc.

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Introduction to I F

• The basic economic principals of efficiency, productivity and least cost

optimization process necessitates the use of inputs both domestic and

foreign, and flow of goods and services across national borders, provided

there are no barriers to such flows.

• The result is the exchange of goods and services involving payments and

receipts as between countries and exchange of one currency for another

and borrowing and lending of money or near money assets across

borders. These transactions and trading in foreign currencies, foreign

assets or liabilities and foreign claims constitute the international financialsystem.

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International Trade

• Balance of Trade and Balance of Payment

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Balance of Trade

• Balance of trade may be defined as difference between Export and

Import of goods and services.

• BOT = Net Earning on Export - Net payment for imports

• If export is more than import, at that time, BOT considered to be

favourable. If import is more than export, at that time, BOT

considered to be unfavourable.

• Solution to unfavourable BOT - To Buy goods and services

from domestic country / Increase Exports

•

•

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• POSITION OF INDIA’S BALANCE OF TRADE AS ON 30.06.2013

• India recorded a trade deficit of 715.31 INR Billion in June of 2013.

• Balance of Trade in India is reported by the Ministry of Commerce and

Industry. India Balance of Trade averaged -120.42 INR Billion from 1978

until 2013, reaching an all time high of 13.91 INR Billion in April of 1991

and a record low of -1111.46 INR Billion in October of 2012.

• India had been recording sustained trade deficits due to low exports base

and high imports of coal and oil for its energy needs. India is leading

exporter of petroleum products, gems and jewelry, textiles, engineering

goods, chemicals and services.

• Main trading partners are European Union countries, United States, China

and UAE.

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Balance of Trade

• Following are main factors which affect BOT -

a) Cost of production

b) Availability of raw materials

c) Exchange rate

d) Prices of goods manufactured at home

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Balance of Payment

•

Balance of payment is flow of cash between domestic country andall other foreign countries. It includes not only import and export of

goods and services but also includes financial capital transfer.

• BOP = BOT + (Net Earning on foreign investment - payment

made to foreign investors) + Cash Transfer + Capital Account +

or - Balancing Item

or

BOP = Current Account + Capital Account + or – Balancing

item ( Errors and omissions)

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Balance of Payment

• Balance of Payment will be favourable, if you have surplus in

current account for paying your all past loans in your capital

account.

Balance of payment will be unfavourable, if you have currentaccount deficit and you took more loan from foreigners. After this,

you have to pay high interest on extra loan and this will make your

BOP unfavourable.

Solution for unfavourable BOP - To stop taking of loan from

foreign countries.

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Balance of Payment

Current Account

Three types of transactions:

1. Economic and Commercial transactions involving exchange of

goods for goods or goods for money abroad – Trade of

merchandise items of a Tangible nature

2. Trade in invisible items – Export /Import of services in the form of

shipping, banking, insurance, tourism, hospitality, IT

communication, technical consultancy , royalties, dividend,interest on loans etc.

3. Unilateral transfers – Gifts, charities, donations, free samples etc

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Balance of Payment

Capital account

These are transactions of a capital nature affecting foreign assets and

liabilities of the various countries.

1. Short term capital movements

2. Long term capital movements

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Components of International Financial System

International Financial system relates to the management of and

trading in International money and monetary assets. The monetaryassets are claims on foreign currency, foreign deposits and

investments and / or foreign assets . The claims may be

denominated in various foreign currencies purchased and sold and

involve exchange as between currencies. Thus these transactions

give rise to:

• i) A foreign exchange transaction involving exchange of currency for

another - Foreign Exchange Market.

• Ii) Borrowing and lending operations in foreign currencies or Trading

in financial assets denominated in foreign currencies – Foreign

Currency Market

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Foreign Exchange Market• International economic and commercial relations between countries

involve exchange of goods and services and payment for these exchanges.

The payments leads to conversion of one currency into another.

• Exchanges between the money and financial assets of one country for

money or financial assets of other country constitutes international

financial transactions. These transactions are put through the foreign

exchange market.

• The demand for and supply of each of the currencies against an

alternative currency determines the rate at which two currencies are

exchanged. This is called the exchange rate and the market is the foreign

exchange market.

• These financial assets could be money or near money assets, cheques,

drafts, mail transfers and other negotiable instruments.

•

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Foreign Currency Market

• In the process of such economic and commercial transactions , a

country can be a net creditor or a debtor. If a country is a net

creditor or has a positive trade surplus or receives more than it pays

out, it has net foreign claims on others. Such claims are held in the

form of deposits, balances etc. abroad or investments in T Bills,Govt and Private securities etc.

• Such claims would lead to international currency holdings which are

generally held in convertible currencies. Any market representing

the demand and supply of such currencies is called the Foreign

Currency market.

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• While the foreign currency market refers to

trading in external or other currencies held

abroad, foreign exchange market refers to the

conversion of such dollars into other

currencies.

• International Capital markets and Bond Markets

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Institutions in International Financial System1. National banks and domestic financial institutions which are authorised

to deal in foreign currencies and foreign credits.

2. International brokers and Security firms of repute

3. Regional or Multi-national banks or Corporations dealing in international

markets and borrowing and lending in these markets

4. Regional Finance and Development Corporations and Banks such as Asian

Development Bank, Commonwealth Finance Corporation, Latin American

Development Bank, African Development Bank etc.

5. International Financial organisations like International Monetary Fund

(IMF), International Bank for Reconstruction and Development (IBRD),

International Finance Corporation (IFC) and International Development

Agency (IDA)

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International Monetary Fund

• Great Depression of the 1930s.

• Countries attempted to shore up their failing economies by sharply raisingbarriers to foreign trade, devaluing their currencies to compete against

each other for export markets, and curtailing their citizens' freedom to

hold foreign exchange.

• World trade declined sharply and employment and living standards

plummeted in many countries.• This breakdown in international monetary cooperation led the IMF's

founders to plan an institution charged with overseeing the international

monetary system—the system of exchange rates and international

payments that enables countries and their citizens to buy goods and

services from each other.• The new global entity would ensure exchange rate stability and encourage

its member countries to eliminate exchange restrictions that hindered

trade.

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•

The IMF was conceived in July 1944, when representatives of 45 countriesmeeting in the town of Bretton Woods, New Hampshire, in United States,

agreed on a framework for international economic cooperation, to be

established after the Second World War. They believed that such a

framework was necessary to avoid a repetition of the disastrous economic

policies that had contributed to the Great Depression.

• The IMF came into formal existence in December 1945, when its first 29

member countries signed its Articles of Agreement. It began operations on

March 1, 1947. Later that year, France became the first country to borrow

from the IMF.

• Presently there are 188 member countries.

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• Objectives of IMF:

Primary - To foster global growth and economic stability

• To promote international monetary co-operation through consultation and

mutual collaboration

• To promote exchange stability and maintain orderly exchange

arrangements and avoid competitive exchange depreciation

• To help members with temporary balance of payment difficulties to tide

over them without resort to exchange restrictions

• To promote growth of multilateralism in trade and payments and thus

expand world trade and aid

• To help achieve the balance of payment equilibrium and promote orderly

international relations

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• The IMF supports its membership by providing:

• Policy advice to governments and central banks based on analysis of

economic trends and cross-country experiences;

•

Research, statistics, forecasts, and analysis based on tracking of global,regional, and individual economies and markets;

• Loans to help countries overcome economic difficulties;

• Concessional loans to help fight poverty in developing countries; and

• Technical assistance and training to help countries improve the

management of their economies.

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Par value system

• The countries that joined the IMF between 1945 and 1971 agreed to keep

their exchange rates (the value of their currencies in terms of the U.S.

dollar and, in the case of the United States, the value of the dollar in termsof gold) pegged at rates that could be adjusted only to correct a

"fundamental disequilibrium" in the balance of payments, and only with

the IMF's agreement.

•

This par value system—also known as the Bretton Woods system—prevailed until 1971, when the U.S. government suspended the

convertibility of the dollar (and dollar reserves held by other

governments) into gold.

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• Since the collapse of the Bretton Woods system, IMF members have beenfree to choose any form of exchange arrangement they wish (except

pegging their currency to gold): allowing the currency to float freely,

pegging it to another currency or a basket of currencies, adopting the

currency of another country, participating in a currency bloc, or forming

part of a monetary union.

• From the mid-1970s, the IMF sought to respond to the balance of

payments difficulties confronting many of the world's poorest countries by

providing concessional financing through what was known as the Trust

Fund. In March 1986, the IMF created a new concessional loan programcalled the Structural Adjustment Facility. The SAF was succeeded by the

Enhanced Structural Adjustment Facility in December 1987.

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• The fall of the Berlin wall in 1989 and the dissolution of the Soviet Union

in 1991 enabled the IMF to become a (nearly) universal institution. Inthree years, membership increased from 152 countries to 172, the most

rapid increase since the influx of African members in the 1960s.

• The IMF played a central role in helping the countries of the former Soviet

bloc transition from central planning to market-driven economies. Thiskind of economic transformation had never before been attempted, and

sometimes the process was less than smooth. For most of the 1990s,

these countries worked closely with the IMF, benefiting from its policy

advice, technical assistance, and financial support.

• By the end of the decade, most economies in transition had successfully

graduated to market economy status after several years of intense

reforms, with many joining the European Union in 2004.

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•

In 1997, a wave of financial crises swept over East Asia, from Thailand toIndonesia to Korea and beyond. Almost every affected country asked the

IMF for both financial assistance and for help in reforming economic

policies.

•

IMF realized that it would have to pay much more attention to weaknessesin countries’ banking sectors and to the effects of those weaknesses on

macroeconomic stability.

• In 1999, the IMF—together with the World Bank—launched the Financial

Sector Assessment Program and began conducting national assessmentson a voluntary basis.

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• During the 1990s, the IMF worked closely with the World Bank to alleviate

the debt burdens of poor countries. The Initiative for Heavily Indebted

Poor Countries (HIPC) was launched in 1996, with the aim of ensuring that

no poor country faces a debt burden it cannot manage.

• In 2005, to help accelerate progress toward the United Nations

Millennium Development Goals (MDGs), the HIPC Initiative was

supplemented by the Multilateral Debt Relief Initiative (MDRI).

•

For most of the first decade of the 21st century, international capital flowsfueled a global expansion that enabled many countries to repay money

they had borrowed from the IMF and other official creditors and to

accumulate foreign exchange reserves.

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• The global economic crisis created the worst recession since the Great

Depression of the 1930s. The crisis began in the mortgage markets in the

United States in 2007 and swiftly escalated into a crisis that affected

activity and institutions worldwide. The IMF mobilized on many fronts to

support its member countries, increasing its lending, using its cross-country experience to advise on policy solutions, and introducing reforms

to modernize its operations and become more responsive to member

countries’ needs. As the apex of the crisis shifted to Europe, the Fund has

become actively engaged in the region and is also working with the G-20

to support a multilateral approach.

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• Upon joining, each member country of the IMF is assigned a quota, based

broadly on its relative size in the world economy.

• A member country's quota subscription determines the maximum amount

of financial resources the country is obliged to provide to the IMF. A

country must pay its subscription in full upon joining the IMF: up to 25

percent must be paid in the IMF's own currency, called Special DrawingRights (SDRs) or widely accepted currencies (such as the dollar, the euro,

the yen, or pound sterling), while the rest is paid in the member's own

currency. (page 18 and 19)

• The quota largely determines a member's voting power in IMF decisions.Each IMF member's votes are comprised of basic votes plus one additional

vote for each SDR 100,000 of quota. The number of basic votes attributed

to each member is calculated as 5.502 percent of total votes.

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• The IMF collaborates with the World Bank, Regional development banks,

the World Trade Organization (WTO), UN agencies, and otherinternational bodies. While all of these organizations are involved in

global economic issues, each has its own unique areas of responsibility

and specialization. The IMF also works closely with the Group of Twenty

(G-20) industrialized and emerging market economies and interacts with

think tanks, civil society, and the media on a daily basis.

• While the IMF's focus is mainly on macroeconomic and financial sector

issues, the World Bank is concerned mainly with longer-term development

and poverty reduction. Given the World Bank's focus on antipoverty

issues, the IMF collaborates closely with the Bank in the area of povertyreduction. Other areas of collaboration include assessments of member

countries' financial sectors, development of standards and codes, and

improvement of the quality, availability, and coverage of data on external

debt.

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•The IMF is led by a Managing Director, who is head of the staff andChairman of the Executive Board. The Managing Director is assisted by a

First Deputy Managing Director and three other Deputy Managing

Directors. The Management team oversees the work of the staff and

maintains high-level contacts with member governments, the media, non-

governmental organizations, think tanks, and other institutions.

• According to the IMF's Articles of Agreement, the Managing Director "shall

be chief of the operating staff of the Fund and shall conduct, under the

direction of the Executive Board, the ordinary business of the Fund.

Subject to the general control of the Executive Board, he shall beresponsible for the organization, appointment, and dismissal of the staff of

the Fund."

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• Current Management Team –

• Christine Lagarde - Managing Director

• David Lipton - First Deputy Managing Director

• Naoyuki Shinohara - Deputy Managing Director

• Nemat Shafik - Deputy Managing Director

• Min Zhu - Deputy Managing Director

• The IMF currently employs about 2,400 staff, half of whom are

economists. Most of them work at the IMF's Washington, D.C.,headquarters but a few serve in member countries around the world in

small IMF overseas offices or as resident representatives.

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International Monetary Fund (Governance

Structure)• The Board of Governors is the highest decision-making body of the IMF. It

consists of one governor and one alternate governor for each member

country. The governor is appointed by the member country and is usually

the minister of finance or the head of the central bank.

• While the Board of Governors has delegated most of its powers to the

IMF's Executive Board, it retains the right to

approve quota increases, special drawing right (SDR) allocations, the

admittance of new members, compulsory withdrawal of members, and

amendments to the Articles of Agreement and By-Laws.

• The Board of Governors also elects or appoints executive directors and is

the ultimate arbiter on issues related to the interpretation of the IMF's

Articles of Agreement. Voting by the Board of Governors usually takes

place by mail-in ballot.

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• The IMF Board of Governors is advised by two ministerial committees,

the International Monetary and Financial Committee (IMFC) and theDevelopment Committee.

• The IMFC has 24 members, drawn from the pool of 187 governors. Its

structure mirrors that of the Executive Board and its 24 constituencies. As

such, the IMFC represents all the member countries of the Fund.

• The Executive Board

• The IMF's 24-member Executive Board takes care of the daily business of

the IMF. Together, these 24 board members represent all 188 countries.

Large economies, such as the United States and China, have their own seat

at the table but most countries are grouped in constituencies representing

4 or more countries. The largest constituency includes 24 countries.

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• The Board discusses everything from the IMF staff's annual health checks

of member countries' economies to economic policy issues relevant to the

global economy. The board normally makes decisions based on consensus

but sometimes formal votes are taken. At the end of most formal

discussions, the Board issues what is known as a summing up, which

summarizes its views. Informal discussions may be held to discuss complexpolicy issues still at a preliminary stage.

• In 2010, the IMF agreed wide-ranging governance reforms to reflect the

increasing importance of emerging market countries. The reforms also

ensure that smaller developing countries will retain their influence in theIMF.

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• The Special Drawing Right (SDR) is an international reserve asset, created

by the IMF in 1969 .

• The SDR is neither a currency, nor a claim on the IMF. Rather, it is a

potential claim on the freely usable currencies of IMF members. Holders

of SDRs can obtain these currencies in exchange for their SDRs

• In addition to its role as a supplementary reserve asset, the SDR serves as

the unit of account of the IMF and some other international organizations.

• Since 1981, The value of the SDR is based on a basket of key international

currencies—the euro, Japanese yen, pound sterling, and U.S. dollar.The U.S. dollar-value of the SDR is posted daily on the IMF’s website. The

basket composition is reviewed every five years by the Executive Board to

ensure that it reflects the relative importance of currencies in the world’s

trading and financial systems.

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• SDR accounts are kept separate from the General Account of the Fund.

• The SDR is like a coupon or a credit facility which can be exchanged for

reserve currency as needed by the user and approved by the fund.

• The Governments of the countries are holders of the SDRs and their

accounts in SDRs are maintained by the Fund through book entries. If anymember wants to use the SDR, it requests the fund to designate another

member to accept them in exchange for a reserve currency to use in

international payments and the latter member is obliged to accept as

designated by the Fund.

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• SDR allocations to IMF members – starting from 1970

• Under its Articles of Agreement, the IMF may allocate SDRs to members in

proportion to their IMF quotas, providing each member with a costless

asset. However, if a member’s SDR holdings rise above its allocation, it

earns interest on the excess; conversely, if it holds fewer SDRs than

allocated, it pays interest on the shortfall.

• There are two kinds of allocations:

• General allocations of SDRs. General allocations have to be based on a

long-term global need to supplement existing reserve assets. Decisions to

allocate SDRs have been made three times: in 1970-72, for SDR 9.3 billion;

in 1979 –81, for SDR 12.1 billion; and in August 2009, for an amount of SDR

161.2 billion.

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• Special allocations of SDRs. A special one-time allocation of SDRs through

the Fourth Amendment of the Articles of Agreement was implemented in

September 2009. The purpose of this special allocation was to enable all

members of the IMF to participate in the SDR system on an equitable basis

and correct for the fact that countries that joined the Fund after 1981—

more than one-fifth of the current IMF membership—had never received

an SDR allocation.

• With the general SDR allocation of August 2009 and the special allocation

of September 2009, the amount of SDRs increased from SDR 21.4 billion to

SDR 204.1 billion (equivalent to about $310 billion as on August 2012).

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