1. Implications for the MNE
Responses to barriers to international funds flows
Advantages of MNE structure
(C) 2016 Melvin H Jameson

2. Context for foreign exchange policy
(C) 2017 Melvin H Jameson

3. The “Impossible Trinity”
It is not possible to implement all of
Full financial integration
Independent monetary policy (control of interest rate policy)
A fixed (or controlled) exchange rate
(C) 2017 Melvin H Jameson

4. With full market integration
Policy implementation requires:
FX policy = currency market intervention
Interest rate policy = financial market intervention (open market operations)
Resulting conflict
Both work through the money supply,
Free exchange means both effects spread to both markets
Can’t use one control (money supply) to steer two objectives (exchange rate and interest rate).
(C) 2017 Melvin H Jameson

5. To control both FX rate and interest rate
Either
Ration currency – at fixed exchange rate (or rates) Or
Ration access to capital
(Or both)
Financial repression = restricted market functioning
(C) 2017 Melvin H Jameson

6. Some responses to financial repression or currency blockage
(C) 2017 Melvin H Jameson

7. Multinational structure and arbitrage
If international capital flows completely unimpeded
(Real) interest rates tend to converge worldwide
“Interest rate parity” theory of exchange rates
Analogous to price convergence under free trade
If market capital flows are restricted but some internal transfers allowed
Interest rate differentials can emerge
Potential arbitrage opportunity for the MNE
To exploit these, or for normal business purposes, consider funds transfer in the face of restrictions
(C) 2016 Melvin H Jameson

8. Direct funds transfer Payment for equity Lending or loan repayment
Dividends
Lending or loan repayment
Principal (intra company loans)
Interest “
Dividends or loan principal transfer after-tax profit
(C) 2016 Melvin H Jameson

9. Barriers or market restrictions
Formal barriers
Exchange controls or direct taxation of transfers
Differential controls or taxation by nationality
Informal barriers
Cost of local information
Difficulty enforcing contracts
capital market imperfections
Interest rate ceilings or credit rationing
Limited liquidity / high transactions costs
(C) 2016 Melvin H Jameson

10. Chinese Case
Limits on moving cash for multinationals: Article: “After earning cash in China, trick is getting it out” WSJ 2/15/12 p. B1 Chinese themselves are now using considerable ingenuity to move cash out of China.
(C) 2016 Melvin H Jameson

11. Response to funds blockage/barriers
Restructure financial cash flows – specifically loans, to avoid the barrier
Parallel loans
Back-to-back loans
(C) 2016 Melvin H Jameson

12. Parallel Loan No funds cross any border.
U.S. parent
Chinese subsidiary
$ Loan
United States
Chinese parent
U.S. subsidiary
¥ Loan
China
No funds cross any border.
Nevertheless, each parent effectively lends to it foreign subsidiary.
(C) 2016 Melvin H Jameson

13. Parallel Loan: alternative structure
Dow U.S.
Monsato
U.S.
$ Loan
United States
China
Dow
¥ Loan
Parallel Loan
No funds cross any border.
Dow effectively lends to Chinese subsidiary.
Monsato borrows from its Chinese subsidiary.
(C) 2016 Melvin H Jameson

14. Parallel Loan (side note)
Note similarity to a currency swap.
As loans are repaid, the U.S. company pays yuan(from sub) and receives $
Hedges against decline in value of yuan reducing value of payments received.
A swap provides this hedge by netting the two interest payments: requiring payment of only the difference resulting from the exchange rate movement.
(C) 2016 Melvin H Jameson

15. Parallel Loan (comment)
This only works in aggregate if desired capital flows are about even. (no net desired flow)
Otherwise, negotiated parallel loan rates are likely to diverge from interest rate parity.
A cost of financial barriers
(C) 2016 Melvin H Jameson

16. Back-to-back loan U.S. parent converts a direct loan to a bank loan.
CitiBank
Deposit
United States
U.S. subsidiary
Venezuela
Back-to-back loan
U.S. parent converts a direct loan to a bank loan.
This may receive more favorable treatment in the event of currency blockage.
Restructuring for better regulatory treatment
(C) 2016 Melvin H Jameson

17. Other means of funds transfer
Payments for goods & services
Transfer prices (amount of payment)
Terms of payment:
Leading or lagging payments
Currency of internal invoicing
Payments for intellectual property or overhead
Royalties
Licensing fees
Charges for centralized overhead (e.g. R & D)
(C) 2016 Melvin H Jameson

18. Transfer prices and tax compliance
Article: “Coca Cola Owes $3.3 Billion in Taxes Over Foreign Transfer Licensing”
WSJ Sept. 19, 2015
(C) 2016 Melvin H Jameson

19. Comments on other means
All tend to transfer (pre-tax) profit within the MNE
Access to these methods is a potential advantage to MNE structure.
Can be viewed as arbitrage opportunities for MNE
(C) 2016 Melvin H Jameson

20. International “arbitrage” opportunities
Financial market arbitrage: Differences in effective interest rates
Tax arbitrage: Differences in effective tax rates CLOSELY WATCHED BY TAX AUTHORITIES
Regulatory system arbitrage: Regulatory treatment depends on reported profit
(C) 2016 Melvin H Jameson

21. Sources of “regulatory arbitrage”
(Non-tax motives for profit shifting)
Labor negotiations
Public relations
Regulation that depends explicitly or implicitly on profit rates
Selective currency blockage
For example trade payments allowed, repatriation of profits not allowed.
(C) 2016 Melvin H Jameson