International Financial Management by Jeff Madura Florida Atlantic University

International Flow of Funds 2 Chapter International Flow of Funds

Chapter key Objectives To explain the key components of the balance of payments; and To explain how the international Trade flows are influenced by economic factors and other factors. To explain how international capital flows are influenced by country characteristics. To explain the Agencies that Facilitate International Flows of trade and capital.

Email/ F.B : nusrat2008noori@yahoo.com Lec# 1 Introduction to Balance of Payments By: Nusrat ullah noori Email/ F.B : nusrat2008noori@yahoo.com

As we already know that ……. In order to carry out international business we have to choose one the methods for multinational business that we already have studied in chapter # 01 (int. trade, licensing, franchising joint venture, DFI etc…) So if we choose any method , the International business is facilitated by markets that allow the flow of funds between countries. And the transactions arising from international business cause money flows from one country to another. The Financial managers of MNCs monitor the balance of these flow of money so that they can determine how the flow of international transactions is changing over time and indicate the volume of transactions between specific countries.

Balance of Payments what is it? Balance of payments (BoP) is an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The BoP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items.

Balance of Payments what is it? A record of all transactions made between one particular country and all other countries during a specified period of time It compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. Balance of payments may be used as an indicator of economic and political stability. For example, if a country has a consistently positive BOP, this could mean that there is significant foreign investment within that country. It may also mean that the country does not export much of its currency.

Components of BoP Current Account, Capital & Financial Account, The three components of Balance of Payments given below. Current Account, Capital & Financial Account, Official Settlement Account.

Balance of Payments components The current account: It summarizes the flow of funds between one specified country and all other countries due to the purchases of goods or services, the provision of income on financial assets, or unilateral current transfers (e.g. government grants). A current account deficit suggests a greater outflow of funds from the specified country for its current transactions. The current account is commonly used to assess the balance of trade, which is simply the difference between merchandise exports and merchandise imports.

Current Account Payments for merchandise and services Merchandise exports and imports represent tangible products that are transported between countries. Service exports and imports represent tourism and other services. The difference between total exports and imports is referred to as the balance of trade. Factor income payments Represents income (interest and dividend payments) received by investors on foreign investments in financial assets (securities). Transfer payments Represent aid, grants, and gifts from one country to another.

Summary of U.S. International Transactions (For the Year of 2000 in Millions of Dollars) Current Account Exports of goods and services and income receipts 1418568 Goods, balance of payments basis 772210 Services 293492 Income receipts 352866 Imports of goods and services and income receipts -1809099 Goods, balance of payments basis -1224417 Services -217024 Income payments -367658 Unilateral current transfers, net -54136 Balance on current account -444667 Source: U.S. Bureau of Economic Analysis

Balance of Payments components 2. Capital and Financial Account : It is the summary of flow of funds resulting from the sale of financial assets between one specified country and all other countries over a specified period of time. It also includes unilateral current transfers E.g. debt forgiveness, transfers by immigrants, the sale or purchase of rights to natural resources or patents. it compares the new foreign 'investments made by a country with the foreign investments within a country over a particular time period.

Capital and Financial Accounts Direct foreign investment Investments in fixed assets in foreign countries Portfolio investment Transactions involving long term financial assets (such as stocks and bonds) between countries that do not affect the transfer of control. Other capital investment Transactions involving short-term financial assets (such as money market securities) between countries.

Balance of Payments components 3. Official Settlement Account : It is the sum of the current account and the capital & financial account. A negative official settlements balance may indicate that a country is draining its official international reserve assets or may be incurring debts to foreign central banks. Official reserves represent the holdings by the government or official agencies of the means of payment that are generally accepted for the settlement of international claims.

Email/ F.B : nusrat2008noori@yahoo.com Lec# 2 Factors Affecting International Flow of Funds By: Nusrat ullah noori Email/ F.B : nusrat2008noori@yahoo.com

Causes of international flow of Funds The general causes of international flow of funds are; International Trade Flow International Portfolio investment Direct foreign investment

1. Factors Affecting International Trade Flows Inflation A relative increase in a country’s inflation rate will decrease its current account, as imports increase and exports decrease. National Income A relative increase in a country’s income level will decrease its current account, as imports increase. Government Restrictions A government may reduce its country’s imports by imposing tariffs on imported goods, or by enforcing a quota. Exchange Rates If a country’s currency begins to rise in value, its current account balance will decrease as imports increase and exports decrease.

2. Factors Affecting International Portfolio Investment Tax Rates on Interest or Dividends: Investors will normally prefer countries where the tax rates are relatively low. Interest Rates: Money tends to flow to countries with high interest rates. Exchange Rates: Foreign investors may be attracted if the local currency is expected to strengthen.

3. Factors Affecting DFI Changes in Restrictions: Privatization: New opportunities may arise from the removal of government barriers. Privatization: DFI has also been stimulated by the selling of government operations. Potential Economic Growth: Countries with higher potential economic growth are more likely to attract DFI. Tax Rates: Countries that impose relatively low tax rates on corporate earnings are more likely to attract DFI. Exchange Rates: Firms will typically prefer to invest their funds in a country when that country’s currency is expected to strengthen.

Email/ F.B : nusrat2008noori@yahoo.com Lec# 3 Agencies that Facilitate International Flow of Funds By: Nusrat ullah noori Email/ F.B : nusrat2008noori@yahoo.com

Agencies that Facilitate International Flow of funds Following are the Agencies which Facilitate international flow of funds. IMF( International Monitory Fund) World Bank Group (IBRD, IDA, IFC, MIGA and ICSID) WTO (world trade organization) BIS (Bank of international settlements) Regional Development Agencies

1. International Monetary Fund (IMF) The IMF is an organization of 183 member countries. Established in 1946, its purpose is; to promote international monetary cooperation and exchange stability; to promote economic growth and high levels of employment; and to provide temporary financial assistance to help ease imbalances of payments. to reduce the impact of export instability on country economies. to provide technical and financial assistance to UDCs

2. World Bank Group Established in 1944, the Group assists development with the primary focus of helping the poorest people and the poorest countries. It has 183 member countries, and is composed of five organizations - IBRD, IDA, IFC, MIGA and ICSID. IBRD : International Bank for Reconstruction and Development Better known as the World Bank, the IBRD provides loans and development assistance to middle-income countries and creditworthy poorer countries. In particular, its structural adjustment loans are intended to enhance a country’s long-term economic growth.

Conti… IDA: International Development Association IDA was set up in 1960 as an agency that lends to the very poor developing nations on highly concessional terms. IDA lends only to those countries that lack the financial ability to borrow from IBRD. IBRD and IDA are run on the same lines, sharing the same staff, headquarters and project evaluation standards.

Conti… IFC: International Finance Corporation The IFC was set up in 1956 to promote sustainable private sector investment in developing countries, by financing private sector projects; helping to mobilize financing in the international financial markets; and providing advice and technical assistance to businesses and governments

Conti… M IGA: Multilateral Investment Guarantee Agency The MIGA was created in 1988 to promote FDI in emerging economies, by offering political risk insurance to investors and lenders; and helping developing countries attract and retain private investment. ICSID: International Centre for Settlement of Investment Disputes The ICSID was created in 1966 to facilitate the settlement of investment disputes between governments and foreign investors, thereby helping to promote increased flows of international investment.

3. World Trade Organization (WTO) Created in 1995, the WTO is the successor to the General Agreement on Tariffs and Trade (GATT). It deals with the global rules of trade between nations to ensure that trade flows smoothly, predictably and freely. Its functions include: administering WTO trade agreements; serving as a forum for trade negotiations; handling trade disputes; monitoring national trading policies; providing technical assistance and training for developing countries; and cooperating with other international groups.

4. Bank for International Settlements (BIS) Set up in 1930, the BIS is an international organization that fosters cooperation among central banks and other agencies in pursuit of monetary and financial stability. It is the “central banks’ central bank” and “lender of last resort.” The BIS functions as: a forum for international monetary and financial cooperation; a bank for central banks; a center for monetary and economic research; and an agent or trustee in connection with international financial operations.

5. Regional Development Agencies Agencies with more regional objectives relating to economic development include the Inter-American Development Bank; the Asian Development Bank; the African Development Bank; and the European Bank for Reconstruction and Development.

Chapter Review Balance of Payments International Flow of Funds Current, Capital, and Financial Accounts International Flow of Funds International Trade Flow International Portfolio investment Direct foreign investment Factors Affecting International Trade Flows Inflation National Income Government Restrictions Exchange Rates

Chapter Review International Capital Flows Factors Affecting DFI Factors Affecting International Portfolio Investment Agencies that Facilitate International Flows International Monetary Fund (IMF) World Bank Group World Trade Organization (WTO) Bank for International Settlements (BIS) Regional Development Agencies

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