Financial Forces

1. Financial Forces six Concept Preview After reading this chapter, you should be able to: 1. realize that much money is made and lost in the foreign currency exchange (Fx). 2. understand Fx quotations including cross rates. 3. recognize currency exchange risks. 4. expect currency exchange controls. 5. anticipate financial forces such as balance of payments, tariffs, taxes, inflation, fiscal and Monterey policies, and differing accounting practices that affect business. chapter

2. Financial Forces six Concept Preview continued After reading this chapter, you should be able to: 6. understand sovereign debt, its causes, and its solutions. 7. know that a Third World vegetable stand might be a better credit risk than a Third World government. 8. know that the U.S. has a net negative international investment position. chapter

3. Tariffs, customs or import duties Taxation Inflation Accounting practices Debt 6-3 Financial Forces • Fluctuating currency values • Foreign exchange quotations • Exchange rate risks • Currency exchange controls • Balance of payments

4. 6-4 Financial Forces • Fluctuating currency values • values change • Foreign exchange quotations • use of US$ • forward rates for Britain, Canada, France, Japan, Switzerland, Germany • premium trade vs. discount

5. 6-5 Key Currency Cross Rateslate New York trading June 4, 1997 Table 6.1 Country Dollar Pound Sfranc Guilder Peso Yen Lira D-Mark Ffranc CdnDlr Canada 1.3763 2.2478 .95246 .70768 .17378 .01184 .01184 .79670 .23609 — France 5.8295 9.5207 4.0343 2.9975 .72605 .05015 .00344 3.3745 — 4.2356 Germany 1.7275 2.8214 1.1955 .88827 .21812 .01486 .00102 — .29634 1.2552 Italy 1697.0 2771.5 1174.4 872.58 214.27 14.598 — 982.34 291.11 1233.0 Japan 116.25 189.86 80.45 59.775 14.678 — .06850 67.294 19.942 84.466 Mexico 7.9200 12.935 5.4810 4.0724 — .06813 .00467 4.5847 1.3586 5.7546 Netherlands 1.9448 3.1762 1.3459 — .24556 .01673 .00115 1.1258 .33361 1.4131 Switzerland 1.4450 2.3600 — .42373 .31484 .07731 .00527 .00036 .35444 .10503 UK .61229 — .42373 .31484 .07731 .00527 .00036 .35444 .10503 .44488 US — 1.6332 .69204 .51419 .12626 .00860 .00059 .57887 .17154 .72659 Source: Dow Jones Source: The Wall Street Journal, June 5, 1997, p. C24

6. 6-6 Exchange RatesTuesday, June 4, 1997 — Sample data Figure 6.2 U.S. $ equiv. Currency per U.S. $ Country Wed Tue Wed Tue Argentina (peso) 1.0014 1.0014 .9986 .9986 Britain (pound) 1.6332 1.6347 .6123 .6117 1-month forward 1.6321 1.6336 .6127 .6122 3-months forward 1.6298 1.6314 .6136 .6130 6-months forward 1.6268 1.6285 .6147 .6141 China (renminb) .1202 .1202 8.3215 8.3219 Commercial rate .03040 .03031 32.900 32.991 Ecuador (sucre) — — — — Floating rate .0002556 .0002562 3,912.50 3,902.50 Israel (shekel) .2934 .2936 3.4078 3.4058 Kuwait (dinar) 3.3014 3.3025 .3029 .3028 Netherlands (guilder) .5142 .5145 1.9448 1.9435 Singapore (dollar) .6989 .6988 1.4308 1.4310 South Africa (rand) .2236 .2236 4.4730 4.4715 Spain (peseta) .006853 .006856 145.93 145.85 SDR 1.3837 1.3876 .7227 .7207 ECU 1.1293 1.1299 — — Source: The Wall Street Journal, June 5, 1997, p. C24.

7. 6-7 Exchange Rates and Risks • Spot rate • exchange rate between two currencies for delivery within two business days • Forward rate • exchange rate between two currencies for delivery in the future, commonly 30, 60, 90, or 180 days • Transaction—risk of value change • Translation risk

8. 6-8 Currency Exchange Controls • Government controls that limit the legal uses of a currency in international transactions • Government sets value regardless of market • Government has to approve foreign currency purchases • Retains funds in the country

9. 6-9 Balance of Payments • If BOP is slipping into deficit, the government is probably considering market or non-market measures to correct or suppress the deficit • Management should be alert for efforts to devalue the currency or deflate the economy • Currency or trade controls may be coming

10. 6-10 Financial Forces • Tariffs, Customs or Import Duties • amount paid depends on classification of goods • Harmonized Code System • Taxation • income, sales, VAT and capital gains • rates, enforcement and compliance differs by country • Inflation • monetary policies deal with the amount of money in circulation and growth • increase savings—decrease velocity—lower inflation • spend income—increases velocity—higher inflation • high rates help borrowers replay with cheaper money

11. 6-11 Nominal and Real Interest RatesApril 13, 1996 Figure 6.4 Short-term interest rates April 10th 1996, % Note: Real interest deflated by consumer-price inflation. Source: The Economist, April 13, 1996, p. 101.

12. 6-12 Inflation Rates in OCED Countries Figure 6.5 77.5 70.1 Interest rates Consumer prices, % change on a year earlier 49.0 Source: The Economist, April 6, 1996, p. 108.

13. 6-13 Financial Forces • Accounting practices • variation by country • translation risk • Debt • US debt is government or corporate bonds • LDC debt often is used to meet current operating expenses • Countries went bust

14. 6-14 Secondary Market Transactions in debt instruments of developing countries and countries in transition (In billions of U.S. dollars) Table 6.2 1993 1994 1995 Total turnover 1,978.9 2,766.2 2,738.8 By country Africa 79.8 111.4 109.2 Asia 18.2 24.7 31.1 Europe 104.5 172.3 314.0 Western Hemisphere 1,621.6 2,259.3 2,284.2 Unspecified 154.8 198.5 — By Instrument Loans 273.6 244.4 175.3 Brady bonds 1,021.3 1,684.0 1,580.3 Corporate and non-Brady sovereign bonds 176.6 164.9 232.8 Local market instruments* 361.9 518.9 572.4 Options and warrants on debt 57.4 142.4 178.0 Unspecified — 11.6 — *Data for 1993 do not include trading in short-term local-market instruments. Sources: Emerging Markets Traders Association and IMF staff estimates.

15. 6-15 External Debt of Selected HIPCs in 1994 Table 6.3 Annual Per Capita Debt GNP Debt as Debt as Service as (in U.S. Percentage Percentage Percentage Country Dollars) of GNP of Exports of Exports Bolivia 770 89.4 390.1 28.2 Ethiopia 100 109.8 630.0 11.5 Mali 250 151.8 589.2 27.5 Mozambique 90 450.4 1,388.7 23.0 Nicaragua 340 800.6 2,286.1 38.0 Tanzania 140 229.5 877.5 20.5 Uganda 190 88.1 1,042.7 45.6 Zambia 350 204.3 560.1 31.5 All low- and 1,090 37.6 162.8 16.6 middle-income countries Source: World Bank, World Development Report 1996.

16. 6-16 Longer Term Solutions 1. Borrowing countries will have to pursue policies ensuring that new money they obtain is used for economic growth rather than consumption, capital flight over-ambitious schemes or armaments 2. Borrowers should build up reserves in good years to withstand the fluctuations in commodity export prices 3. Developed countries must strive for their own economic growth and open their markets to LDC exports 4. IMF and other creditors must not try to enforce too stringent austerity measures on debtors. 5. The IMF, World Bank, and other agencies that aid LDC’s must be assured of sufficient funding so they can take long-term views.

17. 6-17 Longer Term Solutions 6. Parts of huge LDC external debts must be changed in form to types of equity. 7. LDC’s must relax their restrictions on foreign investments and repatriation of profits from existing investments. 8. Blame for the debt crisis… - LDC’s borrowed more money than they could productively invest - LDC’s wasted borrowed money at home or corruptly sent abroad for personal accounts of leaders - lending banks were encouraged to lend by their governments because the governments were thus relieved to that extent of foreign aid - banks made limited inquires into uses of money - banks failed to get collateral to secure the loans

18. 6-18 U.S. Debtnet negative investment position • Over $300 billion of U.S. foreign-owned assets are obligations of the U.S. Treasury or U. S. corporations— face value of debt is subject to constant change. • U.S. foreign assets are often measured at book value which results in an estimated undervaluation of up to $200 billion. • U.S. assets abroad reportedly earn more in interest and dividend per dollar of investment than foreign holdings earn in America. • Although current U.S. net liabilities are immense in absolute terms, they are relatively small in terms of other economic indicators—total U.S. debt is 6% of U.S. GDP. • The most distinctive characteristic of the U.S. foreign debt is its denomination in U.S.$.