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CHAPTER ONE
INTERNATIONAL FINANCIAL ENVIRONMENT
Multinational Business v International Business
Multinational Business refers to an enterprise that operates in more than one country having
its headquarters in a single country whilst international businesses are enterprises that have
branches scattered throughout the world and not having a traceable headquarters in any one
country. International businesses are usually referred to as transnational corporations.
Multinational Financial Activities
Multinational financial activities range from the following areas of raising finance to fund their
operations:
1. Internally generated finance; through branches or head office.
2. Netting off among branches.
3. Grants from the parent company.
4. Raising through equity market; local market or international market.
5. Raising through debt market; local, foreign and euro-bonds.
6. Raising through money market; local market or international market
The following should be discussed in the context of the different needs (e.g. working capital
requirements, capital expenditure, and so on) that are to be financed by the above sources of
finance. Also in the context of the advantages and disadvantages of each of the following to the
MNC and the providers of the finance. The following are the instruments that are usually used
to finance international businesses: money market securities, Letters of Credit, Drafts, Bills of
Lading, Forfeiting, Counter Trade, and Government Assistance to Exporters among others (to be
discussed in Chapter 5).
Goal of MNE Financial Management
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There are so many goals that a multinational enterprise can have. These range from profit
maximisation, corporate responsibility and so on. However the majority can be short term that
is usually advanced by management (also called agents) because of their own needs and
desires. On the other hand there are shareholders (also called principals) of these multinational
corporations that have a long term horizon for the firm. However, the different views of agents
and principals leads to the agency problem and it is the onus of the owners of the business to
direct management and workers towards the overall goal of the firm that is shareholder’s
wealth maximisation. The principals will then incur what is called agents costs. Hence the
overall goal of any multinational corporation should be to maximise the shareholder’s value.
INTERNATIONAL MONETARY SYSTEM
The current world order of international monetary system’s history can be traced back to the
end of World War Two when global leaders led by the United States gathered in Bretton Wood
to map up a new order of the global monetary arrangement. Of interest is the birth the IMF and
the World Bank as institutions that would foster the socio and economic development of the
world.
A variety of agencies have been established to facilitate international trade and financial
transactions. These agencies often represent a collection of nations. A description of some of
the more important agencies follows:
International Monetary Fund
The United Nations monetary and financial conference held in Bretton Woods, new Hampshire,
in July 1944, was called to develop a structured international monetary system. As a result of
this conference, the IMF was formed. The major objectives of the IMF set by the charter are to:
promote cooperation among countries on international monetary issues, provide temporary
funds to members attempting to correct imbalances of international payments, promote
stability in exchange rates, promote free mobility of capital funds across countries, and
promote free trade.
It is clear that the IMF goals encourage increased internationalization of business.
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Before 1973, when the exchange rates were maintained within tight boundaries, the IMF
concentrated on removing currency exchange restrictions and ensuring currency convertibility,
with the goal of encouraging international trade. The inception of floating exchange rates in
1973 and the onset of the 1974 -1975 recession caused concern by the IMF that countries
would attempt to reduce their respective currency values as a means of stimulating exports and
reducing imports. Thus, the IMF offered financing arrangements to countries experiencing large
balance of trade deficits. During the international debt crisis that erupted in August 1982, the
IMF provided financing to many of the countries experiencing debt-repayments difficulties. It
worked with each of these countries individually to develop and implement that would improve
their balance of trade positions.
One of the key duties of the IMF is its Compensatory Financing Facility (CFF), which attempts to
reduce the impact of export instability on country economies. While it is available to all IMF
members, it is mainly used by developing counties. A country experiencing financial problems
due to reduced export earnings must demonstrate that the reduction is temporary and beyond
its control. In addition, it must be willing to work with IMF in resolving the problem.
Each member country of the IMF is assigned a quota based on a variety of factors reflecting
that country’s economic status. Members are required by the IMF to pay this assigned quota.
The amount of funds that each member can borrow from the IMF is dependant on its particular
assigned quota.
The financing by the IMF is measured in special drawing rights (SDRs). The SDR is not a currency
but simply a unit of account. It is an international reserve asset created by the IMF and
allocated to member countries to supplement currency reserves. The SDRs value fluctuates in
accordance with the value of five major currencies: US dollar, German mark, French franc,
Japanese yen, and British pound
This five-currency composite, designed January 1, 1981, replaced the prevailing 16-currency
formula, which was more complex. Each of the five currencies represented by the revised
formula was assigned weights (in accordance with their international importance) to determine
the SDR value. The USD received 42% weight, the German mark 19%, and the remaining
currencies each received a 13% weight.
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The IMF played a major role in attempting to reduce adverse effects of the Asian crisis. In 1997
and 1998 it provided funding to various Asian countries in exchange for promises made by the
respective governments to take specific actions intended to improve economic conditions.
Though the IMF had good intentions, the funding agreements were not always successful. For
example, the IMF agreed to a USD43 billion funding for Indonesia. The negotiations of the
agreement were tense, as the IMF demanded that President Suharto break up some of the
monopolize run by the Suharto’s friends and family members and to close some weak banks.
Yet, citizens of Indonesia interpreted the closure of weak banks as a banking crisis and then
withdraw their deposits from all banks. In January 1998, the IMF negotiated many types of
economic reform, and Suharto agreed to them. However, the reforms may have been overly
ambitious, and President Suharto did not accommodate the demands of the IMF to reform
Indonesia’s economy. The IMF agreed to renegotiate terms in March 1998 in a continuing effort
to rescue Indonesia, but these efforts signaled that a country did not have to meet the terms of
the agreement to obtain funding. A new agreement was completed in April, and the IMF
resumed its payments to support a bailout of Indonesia. In May 1998, Suharto abruptly
discontinued subsidies for gasoline and food, which lead to riots. Suharto blamed the riots on
the IMF and on foreign investors who wanted to acquire assets in Indonesia at depressed
prices.
World Bank
The International Bank for Reconstruction and Development (IBRD) also referred to as the
World Bank (WB) was established in 1944. Its primary objective is to make loans to countries in
order to enhance economic development. For philosophy the WB’s objective is profit-oriented.
Therefore, loans are not subsidized but are extended at market rates to governments (and their
agencies) that are likely to make repayment.
One of the WB’s key facilities is the Structural Adjustment Loan (SAL) facility established in
1980. The SALs are intended to enhance a country’s long-term economic growth. For example,
SALs have been provided to Turkey and to some of the less developed countries (LDCs) that are
attempting to improve their balance of trade.
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Because the WB provides only a small portion of the financing needed agreements needed by
the developing countries, it attempts to spread its funds by entering into co-financing
agreements. Co-financing is performed in the following ways:

Official aid agencies. Developing agencies may join the WB in financing development
projects in low-income countries.

Export credit agencies. The WB co-finances some capital-intensive projects that are also
financed though export credit agencies.

Commercial banks. The WB has joined the commercial banks to provide financing for
private sector development.
The World Bank has recently established the Multilateral Investment Guarantee Agency
(MIGA), which offers various forms of political risk insurance. This is an additional means (along
with its SALs) by which the WB can encourage the development of international trade and
investment.
International Development Association (IDA)
The International Development Association was created in 1960 with country development
objectives somewhat similar to those of the WB. Yet, its loan policy is more appropriate for less
prosperous nations. The IDA extends loans at low interest rates to poor nations that cannot
qualify for loans from the WB.
Bank for International Settlements
The Bank for International Settlements (BIS) attempts to facilitate corporation among counties
with regard to international transactions. It also provides assistance to countries experiencing a
financial crisis. The BIS is sometimes referred to as the “central banks’ central bank” or the
“lender of last resort”. It played an important role in supporting some of the less developed
counties during the international debt crisis in the early and the mid-1980s.
INTERNATIONAL DEBT CRISIS
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A debt crisis is situation where a country has accumulated a very large debt and it is unable to
voluntarily continue to service it.
History of The Debt Crisis
Discussion in class.
1. Global economic shocks

Sharp increase in oil prices (1979-1981)

World wide recessions in the 1980s

A sharp increase in the rate of interest (1979-1983)
2. Poor economic policies and planning
3. Unfavorable weather conditions
4. Protectionism from Europe
Solutions to the Debt Problem
1. Embarking on ESAP
ESAP leads to liberalization of the economy. It creates conditions that are favorable for
investors hence it results in capital inflows. That is, both domestic and foreign investors
will be attracted to invest in the country, leading to economic growth.
2. Debt rescheduling
It was done in 1982 and the aim is to extend the repayments period of countries so that
they can have a debt relief.
3. Debt cancellation and repudiation
This is possible if a very powerful delegation is sent to the Paris Club to appeal for debt
cancellation.
4. Debt Equity swaps
Debt Equity swaps increase direct investment, proposal to sell shares in the export
earnings of the debtors and in the indexation of payments to export prices would all
charge the form of the debt. The price at which the debt is swapped for equity by the
debtor country may afford the debtor some relief.
5. Increased concessionary lending
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Increased concessionary lending to productive sectors only. In this case, the leader puts
some strings or conditions to his funds. For example, the lender can order the borrower
to invest in a certain sector and to sell to a specific country or region.
BALANCE OF PAYMENTS
Definition of the Balance of Payments
Is a systematic record of the economic transactions between residents of the exporting country
and residents of the foreign countries during a certain period of time or
Is the difference between the total earnings on both invisible and visible items and total
expenses. In order to know the position as regards international payments, government compiles
records of transactions. This record of transactions is thus called the Balance of Payments (BOP).
The balance of payments is a record of one country's trade dealings with the rest of the world.
Any transaction involving Zimbabwean and foreign citizens is calculated in dollars. Dealings
which result in money entering the country are credit (plus) items while transactions which lead
to money leaving the country are debit (minus) items.
Components of the Balance Of Payments

The balance of payments can be split up into three sections:
1. the current account which deal with international trade in goods and services;
2. transactions in assets and liabilities which deals with overseas flows of money from
international investments and loans;
3. Monetary Account which deals with foreign currency reserves and transactions with
multilateral bodies.
Current Account
The current account consists of international dealings in goods (visible trade) and services
(invisible trade). It records all transactions in goods and services, ie. visibles and invisibles.
Receipt of interest , profits and dividends on loans and investments in foreign countries; earnings
from tourism and transportation and remittances home of income earned by nationals working
abroad are included in this account as invisibles.
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Example of current account 1985
Debits
$m
Credits
Visible imports
80 140 Visible exports
$m
Balance Јm
78 072 -2 068
Invisible imports 75 007 Invisible exports 80 027 5020
By referring to above table you can see that in 1985:

Zimbabwe bought $80 140 million worth of goods made overseas.

Zimbabwe sold $78 072 million worth of goods overseas.

The difference between visible exports and imports is known as the balance of trade or
visible balance. The amounted to -$2 068 million.

Zimbabwe bought $75 007 million worth of foreign-produced services.

Zimbabwe sold $80 027 million worth of services overseas.

The difference between invisible exports and imports is called the invisible balance. This
amounted to $5 020 million.
Adding the balance of trade and balance on invisibles together gives the balance on the current
account. A deficit on the current account means that more goods and services have been
imported into the country than have been sold abroad. A surplus on the current account means
more goods and services have been exported than imported.
Transactions in Assets and Liabilities/ Capital account
The transactions in assets and liabilities section of the balance of payments shows all movements
of money in and out of the country for investment. This may be direct investment - investment in
productive capacity (when firms invest in other countries to increase capital in these countries),
or portfolio investment - investment in shares ,bonds or other assets in foreign countries. Changes
in assets will be outflows from Zimbabwe, as Zimbabwean investors invest money overseas.
These flows will be debits to the Zimbabwe’s Balance of Payments. Changes in liabilities will be
credits to the Zimbabwean Balance of Payments as overseas investors invest money into the
country (Zimbabwe)
Monetary Account
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This is also called the official financing account. It records changes in the country’s official
foreign currency/exchange reserves (consisting usually of a mixture of gold and foreign
currencies) plus transactions with the IMF and other financial institutions.
Balance of Payments Problems
Balance of payments deficit
This is of concern especially in developing countries because it affects the ability of those
countries to trade with other countries. A balance of payments deficit is a major problem if it is
persistent. This can be the result of excessive purchases of foreign goods and services or
excessive Zimbabwean investment overseas. Faced with existing or projected balance of
payments deficits on the combined current and capital accounts a variety of policy options are
available:
Correcting a Balance of Payments Deficit
1. Long term capital from the rest of the world. This has the disadvantage of external
indebtedness.
2. Using foreign currency reserves- this is a short term measure because most non-oil producing
developing countries have very few months in which to exhaust this.
3. Attracting additional inflows of short-term capital by raising interest rates. Lack of stability in
developing countries means that there is no guarantee funds will remain in the countries, i.e.
there is capital flight.
4. Import substitution- this is the local production of previously imported goods. This requires
the importation of capital equipment and protection of the infant industry by imposing tariffs or
bans on imported goods.
5. Exchange control – this is designed to control foreign currency reserves. The foreign currency
is rationed so that the most pressing needs of the country will be given top priority when the
funds are allocated., eg. capital goods and essential raw materials. Measures also include import
licensing as well as creating a state monopoly tasked to import essentials.
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6. Use of multiple exchange rates- different rates for currencies/ transactions. Essentials such as
exports, tourism and essential inputs for industry would have a separate rate(s) of exchange to
encourage them while for nonessentials they would be discriminatory . In other words there is a
multi-tiered market for foreign exchange.
7. Disguised depreciation- this is a policy whereby there is a deliberate effort by government to
make imports more expensive. This includes raising import duties, taxing invisibles, taxing
remittances abroad, subsidise exports, charging high fees on sales of foreign currency. This
policy is deflationary and also has loopholes.
1. Devaluation- reducing the external value of a currency. This increases the volume of sales
abroad.
2. Promoting ting export expansion- drawbacks of duty, export incentive schemes.
3. Encouraging more private investment and seeking more foreign assistance. Much of the
foreign aid comes in the form of loans which have to serviced. Interest has to be paid on the
loans. The principal has also to be repaid in future.
Balance of Payments Surplus
This is also a cause for concern because if it is persistent, partners may retaliate by introducing
import controls etc. A surplus implies an overvaluation of currency and this leads to exports
becoming less competitive on the world market. It could also be inflationary because , it is
argued by monetarists that it leads to an increase in money supply. A persistent surplus could
mean a depression of domestic living standards.
Correcting a Balance of Payments Surplus
An unwanted balance of payments surplus can be the result of excessive foreign investment in
Zimbabwe. This will place a future strain on the invisible balance. A reduction in interest rates (
an outflow of funds on the capital account) or the scrapping of protectionist measures (restrictive
exchange controls) will correct the surplus.
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