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INTERNATIONAL

BUSINESS
Objectives of Session One
• International business and drivers, need for international business
• What is an MNC, Pros and cons for an MNC in a country especially in a
developing country like India
• Country competitiveness and whether India is competitive, discussions
on India’s infrastructure and other environment
• Opportunity scanning for international business in the manufacturing
and service sectors of India
• Modes of entry into a country with examples of how and why different
MNCs have entered into India
• FDI and its economic, political and operational impacts on a country and
on India
• FIIs and their impact on the Indian industries and stock exchange
 
WHEN IB

• when businesses cross borders: (subsidiaries)

• production and operations, and marketing is done internationally,

• human resources belong to more than one country

• international investment is involved,

• the business is international

• of products, Mcdonald’s

• of markets, Harry Ramsden


DRIVERS
• Worldwide trend of the economies of the world becoming
borderless and interlinked.
• National economies merging into an interdependent global
economic system.
• Declining trade and investment barriers
• Perceived distances are shrinking due to advances in transportation
and telecommunications.
• Material culture is beginning to look similar.
• Technological change: Microprocessors and Telecommunications
• The Internet and World Wide Web
• Changing demographics
The Shrinking Globe-The death of distance
1500-1840

Best average speed of 1850-1930


horse-drawn coaches and
sailing ships, 10mph.

Steam locomotives average 65mph.


Steamships average 36mph.
1950s

1960s
Jet passenger aircraft
500-700mph.
The Changing World Order
• Apartheid
• Berlin wall
• Disintegrated USSR
• The fall of Communism in Eastern Europe and the former Soviet
Union.
• Czechoslovakia has divided itself into two states.
• Yugoslavia has divided into 5 (often warring) successor states.
• Pro-democracy movement (suppressed) in China.
• Latin America has seen both democracy and free market reforms.
• NEP of India
WHY AN MNC?

• brings in additional capital


• brings in additional revenue via taxation
• technology transfer to local firms
• managerial knowhow
• skill development and training
• employment creation
• infrastructure development
• industry linkage effects
• export enhancement
WHY ARE MNCS CRITICISED ?

• SOVEREIGNTY (NIGERIA, EAST INDIA COMPANY)


• ECONOMIC OBJECTIVES(KFC,ENRON)
• JUNK TECHNOLOGY
• CULTURAL DEGRADATION
• WAGE DIFFERENCES
• POLLUTION(NAFTA,UNION CARBIDE)
MNCS HAVE THEIR USES

• JOBS
• MANAGEMENT PRACTICES
• TECHNOLOGY TRANSFER
• QUALITY OF LIFE
• UNIVERSALISATION OF CULTURE, STANDARDISATION,
• NEGOTIATION SKILLS.
Country Competitiveness

IS INDIA COMPETITIVE?
Country Competitiveness: a country’s ability to generate
wealth in comparison to other countries
Factor Endowments:
– natural resources
– climate
– location
– demographics
The Country Context

• National contexts differ in a number of respects:


– Economic system
– Political system
– Legal system
– Cultural system
• Their unique interactions make up the country’s political economy
• This in turn influences the competitive environment for MNCs
Advanced Factor Endowments:
• communications
skilled labor
research
technology
• Are the result of investment by people, companies, government.
• Lead to competitive advantage.
OTHER COUNTRY FACTORS

• Purchasing Power Parity: The number of units of a country’s


currency required to buy the same amt of goods/services in the
domestic market as one $ would buy in US
• India is the second largest among developing nations based on the
purchasing power parity indicator.
• Institutions supporting science, education and innovation
• Infrastructure development (power and energy, roads and ports,
communications)
• Openness or closedness of economy (international orientation)
IS INDIA COMPETITIVE?
OUR STRENGTHS

Political System: Democracy


– Government by people exercised directly or through elected
representatives.

MIXED ECONOMY:
• Consumers influence production by exercising their power of choice
• Legal and institutional frameworks to safeguard economic choice
Global services location index by AT Kearney.
• India is the best place to start a business
• Has displaced the US to become the second-most
favoured destination for foreign direct investment after
China.
 Been named as the top reformer in South Asia in the
annual Doing Business Report issued by the International
Finance Corporation (IFC).
 In 2006, an international consultancy firm rated India
second, ahead of the US, in the FDI Confidence Index,
while UNCTAD put India as the third most attractive
destination in the world for FDI.
• Fifth largest economy in the world, ranking above
France, Italy, the United Kingdom, and Russia
• Has the third largest GDP in Asia.
• Massive market
• Exceptional economic prospects
• Little external susceptibilities
• Steady price levels
• A fair amount of candidness in business dealings
• A sizeable English-speaking population.
• Host-country policies that suit foreign investors,
such as promotion of private ownership and
financial market regulation.
• India is the software super power,
• Houses a large number of IT Parks, Business
Centres and SEZs in Bangalore, Gurgaon, Noida,
Hyderabad, Chennai, Chandigarh, Kolkata, Mumbai
and Pune.
• India is the world's most preferred manufacturing
“hub”.
Other unique Strengths
Indian Youth

• Some 65 percent of India is below 35 and 50 per cent


below 25. In 2025, the median age for India will be 31,
against 39 for the US and China and 44 for Russia and the
UK.
• The share of those aged 65 and above in the total
population is less than 5 percent in India, compared to 19
percent in Japan, 18 percent in Germany, 12 percent in the
US and close to 8 percent in China.
The power of Knowledge

• Indians have become the "brains of the world", backed by


the excellent English and communication skills.
• IITs, IIMs and other institutions
• Information Technology (IT) services, Business Process
Outsourcing(BPO) and now Knowledge Process
Outsourcing(KPO)
• Professionally educated and experienced manpower.
Enterprise

• IIM students are turning down Rs 1 crore plus salary to start ventures
of their own.
• The fear of failure has vanished.
• India's roaring entrepreneurial culture has also outbid Chinese in
serious business overseas.
• A recent study by the Duke University’s School of Engineering and
University of California's Berkley School of Information reveals that
between 1996 and 2006,Indian immigrants founded more engineering
and technology companies in the us than Chinese and Taiwanese and
British immigrants put together.
• In fact, one in every four-technology companies set up by immigrants
had an Indian founder.
Indian Software Industry is estimated to
be worth USD 1.2 billion.

• More companies are receiving the ISO 9000 certification


• Toyota Chairman Okuda Hiroshi praised the quality of
products made in India, which he said was better than
even Japanese companies.
INDIA’S FOREIGN TRADE: AUGUST, 2008

A. EXPORTS

• Exports during August, 2008 were valued at US $ 16005 million


which was 26.9 per cent higher than the level of US $ 12614 million
during August, 2007.
• In rupee terms, exports touched Rs. 68721 crore, which was 33.5 per
cent higher than the value of exports during August, 2007.
• Cumulative value of exports for the period April- August, 2008 was
US$ 81225 million (Rs. 342477 crore) as against US$ 60101 million
(Rs. 246180 crore)
• registering a growth of 35.1 per cent in Dollar terms and 39.1 per
cent in Rupee terms over the same period last year.
C. CRUDE OIL AND NON-OIL IMPORTS:

Oil imports during August, 2008 were valued at US $ 10962


million which was 76.7 per cent higher than oil imports valued at
US $ 6202 million in the corresponding period last year.

Oil imports during April- August, 2008 were valued at US$ 45967
million which was 59.6 per cent higher than the oil imports of
US$ 28798 million in the corresponding period last year.
B. IMPORTS

Imports during August, 2008 were valued at US $ 29946


million representing an increase of 51.2 per cent over the level
of imports valued at US $ 19805 million in August, 2007.
In Rupee terms, imports increased by 59 per cent. Cumulative
value of imports for the period April- August, 2008 was US$
130364 million (Rs. 550123 crore) as against US$ 94664
million (Rs. 387791 crore)
registering a growth of 37.7 per cent in Dollar terms and 41.9 per
cent in Rupee terms over the same period last year.
• Non-oil imports during August, 2008 were estimated at US $ 18985
million which was 39.6 per cent higher than non-oil imports of US$
13603 million in August, 2007.
• Non-oil imports during April- August, 2008 were valued at US$
84397 million which was 28.2 per cent higher than the level of such
imports valued at US$ 65846 million in April- August, 2007.
D. TRADE BALANCE

• The trade deficit for April- August, 2008 was estimated at US $ 49139
million which was higher than the deficit at US $ 34543 million during
April- August, 2007.
• Steel tycoon Lakshmi Niwas Mittal has pledged an investment of
about US$ 20 billion for building two 12-million-tonne steel plants
in the states of Jharkhand and Orissa.
• Vodafone, the world's second-biggest mobile firm, plans to spend
US$ 2 billion a year on capital expenditure in India.
• Eyeing the projected 15 per cent growth in the luxury car market
segment, DailmerChrysler India Pvt Ltd, makers of Mercedes-Benz
cars, has decided to set up a new plant in Pune.
• Israeli mall developer Plaza Center NV will invest US$ 1.22 billion
over the next five-seven years to set up 50 malls in India.
• Nokia plans to invest US$ 100 million in India in the next three
years to ramp up its capacity in Chennai.
• US-based aircraft engine manufacturer, Pratt and Whitney, plans to
invest about US$ 30 million in the infotech and spare parts
manufacturing sector.
INDIA ABROAD-The year 2006 marks the point when, 60 years after
independence from colonial rule, Indians are investing more abroad
than the country is receiving as foreign direct investment (FDI).
• The Mukesh Ambani-owned Reliance Industries, India’s second largest
private firm, aims to be among the top 10 in the list.
• With Novelis, Kumar Birla's Hindalco Industries will definitely be
entering the list, three years ahead of its target year.
• Indian firms, like Videocon, Moser Baer and Bharat Forge have
emerged as global leaders in their respective sectors.
• 'The Apollo Group of Hospitals may strike cross border deals through
strategic partners with some of the local hospital chains overseas while
pursuing mergers and acquisitions in the US and Europe’.
• Nicholas Piramal India Ltd plans to invest $50 million over a three-year
period in its plants in the UK and India
• In the energy sector, India's Suzlon Energy Limited, the world's fifth
largest wind turbine manufacturer, bid $1.3 billion for Germany's RE
power.
A BCG report said that the axis of corporate power was shifting towards
the BRIC (Brazil, Russia, India and China) countries. It identified 100
new global challengers from these nations, including 21 Indian firms,
including Bharat Forge, Hindalco, Videocon and Tata Steel.
• A McKinsey study (2006) found the dynamics in emerging markets like
India "actually provide an invaluable springboard" for their companies to
go global.
• A 2006 study by Mape, an investment bank, concluded "the Indian
Multinational Company (MNC) has finally come of age" and "Indian
buyers have become a force to reckon with in many industries such as
pharma, auto components and oil and gas".
• Manufacturing and construction, which grew at 12 per cent in 2006-
07, decelerated by about 2.5 percentage points in 2007-08. The slower
growth of consumer durables was the most important factor in the
slowdown of manufacturing.
• There was a sharp acceleration in the growth of manufacturing from
3.3 per cent during the Ninth Five Year Plan to 8.6 per cent during the
Tenth Five Year Plan. The average growth of manufacturing during
the five years ending 2007-08 is expected to be about 9.1 per cent.
• The contribution of manufacturing to overall growth increased from
about 9.6 per cent during the Ninth Five Year Plan to about 17.7 per
cent during the Tenth Five Year Plan.
• Among the subsectors of services, “transport and communication”
has been the fastest growing with growth averaging 15.3 per cent
per annum during the Tenth Five Year Plan period followed by
“construction”. The impressive progress in the telecommunication
sector and higher growth in rail, road and port traffic played an
important role in the growth of this sector.

• The two other sectors whose contribution to growth has increased


over the two plans are construction and
communications. The contribution of the construction sector
increased to 10.8 per cent during the Tenth Five Year Plan from 7.5
per cent during the Ninth Five Year Plan, while that of telecom
increased to 11.4 per cent from 6 per cent over the two plans.
• The growth of “financial services” comprising banking, insurance
and business services, after declining to 5.6 per cent in 2003-04
bounced back to 8.7 per cent in 2004- 05, 11.4 per cent in 2005-06
and 13.9 per cent in 2006-07. Manufacturing, construction and
communication were the leading sectors in the acceleration of
growth during the Tenth Five Year Plan
Attention needing areas

• Education
• Infrastructure
• Health: the Indian health system is ranked 118 among 191 WHO
member countries on overall health performance
• Judicial system
• Etiquette
India Inc’s bottlenecks

• Irrational policies (tax structure and trade barriers).


• Low investment in infrastructure - physical and information technology.
• Slow reforms (political reforms to improve stability, privatization and
deregulation, labour reforms).
Starting a business

• It took 35 days to register a company in Mumbai in 2006 as compared to


71 days in 2005 and 89 days in January 2004.
• The OECD average is 17 days. Within India the shortest time to start a
business is 35 days in Mumbai. It takes the longest in New Delhi and
Bhubaneshwar (52 days).
The number of procedures to start a
business

The number of procedures to start a business in India is 11 as


compared with the OECD average of 7 procedures and the South
Asia average of 8.
Official costs of starting a business

In India, a minimum capital requirement is not required. Yet, the


official costs to start a business are high, at 74% of income per
capita. This has risen from 62% over a year, following increases in
VAT registration fees.
Costs in India are far above global benchmarks which are as low as
0% of income per capita in Denmark and 9% of income per capita
in China, whereas the South Asia average is 47% and the East
Asia average is 43%.
Dealing with licenses
 
Obtaining the necessary licenses to construct a warehouse is 606% of
income per capita. It requires 20 procedures and 270 days.
The South Asia average is 16 procedures and 226 days, costing 375% of
income per capita. It ranks 155th in the world on the ease of licensing.
Registering property

Regarding the ease of registering property, India ranks 110th in the world.
The process itself takes 6 procedures and 62 days.

When contrasted, it takes only 1 day in Norway, 32 days in China and 47


days in Brazil.
Costs of registering property

Entrepreneurs in India must shell out 8% of the property value to register


a transfer of ownership.

On an average, in South Asia property registration costs 5% of the


property value. It is only 3% in China, and there is no such cost involved
in Saudi Arabia.
Getting credit

• India gets the 65th rank on the simplicity of getting credit for
business purposes.
• India scores 5 out of 10 on the legal rights index, which measures the
degree to which collateral and bankruptcy laws facilitate lending.
Paying taxes

• India ranks 158th in ranking on the ease of paying taxes. and the
time spent on complying with tax requirements is is 264 hours
per year. The tax regime requires 59 separate payments annually.

• Over 81.1 percent of the commercial profits is payable in tax. In


China, businesses spend 872 hours per year and in Brazil 2,600
hours per year, the tax rate of 81 percent is higher than that of
Brazil at 71.7% and China at 77.1%.
Trading across borders

India ranks 139th on the ease of trading across borders, whereas


Afghanistan is ranked 152 and Bhutan is ranked at 150. Exporting
goods takes 27 days, over the previous year’s time of 36 days.
The East Asia average is 24 days and in China it takes 18 days to
export goods.
Importing in India takes 41 days to complete import procedures as
contrasted with East Asia, where importing requires 26 days. It takes
22 days to import in China.
Documents in trading
Indian exporters submit 10 documents, compared with the regional
average of 8 documents and the East Asia average of 7 documents.

For importing it takes 15 documents in India contrasted with 9 documents


in China.
Enforcing contracts

Commercial disputes before courts in India are among the most


lengthy, costly and complex in South Asia and globally, resulting in a
rank of 173 on the ease of enforcing contracts.
It takes 1,420 days to enforce a contract in India, compared with 969
days on an average in South Asia, 351 days on an average in OECD
countries, 450 days in Malaysia and only 292 days in China.
Court costs and attorneys’ fees enhance it to 36% of the value of the
claim. In China, the cost is 27% of the claim and on an average in
South Asia 26.4%.
Procedures to enforce a contract

There are 56 procedures to enforce a contract in India, only 39


procedures are required to be enforced on an average in South Asia,
32 procedures on an average in East Asia, and 31 procedures in
China.
Ease of closing a business

Insolvency procedures in India are among the most tedious in South


Asia. India gains a rank of 133 on the ease of closing a business.

Going through bankruptcy takes 10 years. In South Asia, the time to go


through bankruptcy on an average is 4 years, in East Asia it is 2 years
and in OECD countries it is one year.
Claims on closing a business

In India, claimants can expect to recover less than 13 cents on the dollar,
as compared to an average of 20 cents in South Asia, 18 cents in Sub-
Saharan Africa, 32 cents in China and 93 cents in Japan, which is the
highest in the world.
Further, are the government's opaque policies:
• absence of clarity relating to norms for acquiring agricultural land for
setting up industrial units, especially those located in special economic
zones or export-oriented localities where industrial ventures receive
tax concessions as well as regulations for inviting foreign investment
in retail concerns.

• Over the coming decade or so, India needs to invest at least 150 billion
dollars for improving its infrastructure and a similar amount on retail
ventures if the economy is to continue to grow at 8 percent each year.
MODES OF ENTRY INTO
INTERNATIONAL BUSINESS
MODES OF ENTRY

EXPORTING:DIRECT EXPORTS ,INDIRECT EXPORTS,


INTRACORPORATE TRANSFERS
DECISION FACTORS
OWNERSHIP
ADVANTAGES
INTERNATIONAL LICENSING
LOCATION 
ADVANTAGES
INTERNALISATION 
ADVANTAGES
INTERNATIONAL FRANCHISING
OTHER FACTORS:
NEED FOR 
CONTROL
SPECIALISED MODES:
RESOURCE
MANAGEMENT CONTRACTS, TURNKEY 
 AVAILABILITY PROJECTS
GLOBAL STRATEGY
FOREIGN DIRECT CONTRACTS:
GREENFIELD STRATGEY, ACQUISITION
 STRATEGY, JOINT VENTURE
European Acquirers – Indian Targets
Sectoral Split
Telecom
17%
Transport
• Telecom 3%
Chemicals &
– Vodafone’s € 10.5bn announced acquisition Materials
of Hutch’s 67% stake in Hutchison Essar Mining 6%
24%
– In 2005, Vodafone also picked up 6% stake
IT& ITeS
in Bharti Airtel for € 686m 7%

• Mining
– UK based Vedanta Resources’ recent
announced acquisition of 71% stake in Sesa Others
Goa for € 972m 7%
Cement

• Cement Consumer
23%

– Swiss cement major, Holcim picked up 20% 13%

stake in Gujarat Ambuja Cement for € 466m


Source: Merger Market, Rothschild analysis
Note:1) Includes all announced deals from 2004 till 2007 YTD
2) Excludes Vodafone – Hutchison Essar deal

54
European Acquirers – Indian Targets
Top 10 Deals (2005 – 2007YTD)
Year Acquirer Country Target Deal Value
(€ m)
2007 Vodafone Group PLC UK Hutchison Essar (67%) 10,507
2007 Vedanta Resources PLC UK Sesa Goa (71%) 972
2005 Vodafone Group PLC UK Bharti Airtel (6%) 686
2006 Holcim Ltd Switzerland Gujarat Ambuja (20%) 466
2005 Michael Huber Muenchen Germany Micro Inks Ltd (71%) 246
2004 Hewlett-Packard Leiden Netherlands Digital Globalsoft (49%) 245
2005 Holcim Ltd Germany Ambuja Cement (67%) 182
2005 SABMiller PLC* UK Shaw Wallace 108
2006 Ciments Francais France Zuari Cement (50%) 100
2004 DHL Worldwide SA Belgium Blue Dart (68%) 97
Source: SDC, Merger Market, Rothschild analysis
Note *- Through its Indian Subsidiary, Mysore Breweries

55
Foreign Direct Investment (FDI) is defined as
"investment made to acquire lasting interest in enterprises
operating outside of the economy of the investor."

The FDI relationship consists of a parent enterprise


and a foreign affiliate, which together form a Trans-
national Corporation (TNC).
When is FDI Preferable to Trade?
• Transportation costs too high for exporting
• Tariff and non-tariff barriers very high
• Lack of excess domestic capacity
• Scale economies not significant in competitiveness (especially when
products are more differentiated)
• country-of-origin effects important (preference for local production)
• Location specific advantages such as natural resources
Why Do Firms Invest Overseas?

• Trade Barriers
• Labour Market Imperfections
• Intangible Assets
• Vertical Integration
• Product Life Cycle
• Shareholder Diversification
Labour Market Imperfections

Persistent wage differentials


across countries exist. This
is one on the main reasons Country Hourly Cost
MNCs are making
substantial FDIs in less
Germany $27.37
developed nations. Japan $21.38
France/U.S. $17.10
Israel $9.06
Taiwan $5.47
Mexico $2.57
• El Salvador 1.25
• Finland 14
• France  9.4
• Germany 17.06
• Greece  5.92
• Guatemala 1.27
• India                     0.23
• Ireland 14.66
• Israel      10.56
• Japan 13.34
• Jordan 1.41
• , Republic of Korea 9.07
• Malaysia 2.16
• Mauritius 1.25
• Mexico 2.49
• Netherlands 19.71
• New Zealand 10.96
• Nicaragua 0.94
• Norway 19.73
Intangible Assets

• Coca-Cola has a very valuable asset in its closely guarded “secret


formula”.
• To protect that proprietary information, Coca-Cola has chosen FDI
over licensing.
• Since intangible assets are difficult to package and sell to foreigners,
MNCs often enjoy a comparative advantage with FDI.
Vertical Integration
• MNCs may undertake FDI in countries where inputs are available in
order to secure the supply of inputs at a stable accounting price.
• Vertical integration may be backward or forward:
– Backward: e.g. a furniture maker buying a logging company.
– Forward: e.g. a U.S. auto maker buying a Japanese auto
dealership.
Product Life Cycle

• U.S. firms develop new products in the developed world for the
domestic market, and then markets expand overseas.
• FDI takes place when product maturity hits and cost becomes an
increasingly important consideration for the MNC.
Product Life Cycle

The U.S.
Quantity

production exports
imports
ptio n
ns u m
co

New product Maturing product Standardized product


Less advanced 
countries
exports
Quantity

n
p tio
su m
con
imports
production

New product Maturing product Standardized product


Political Impact of FDI

• Countries are concerned that MNCs are foreign-policy instruments of


home govt.
– East India Co. and Great Britain
– United Fruit in Central America
– Chile and the overthrow of the Allende govt.
• Extraterritoriality: when govts apply own laws to firms’ foreign
operations
• Bribery a big issue (Foreign Corrupt Practices Act, 1977)
Political Impact of FDI

• Foreign control of key or sensitive sectors


• Undue influence in local politics of foreign country
• MNCs can play countries off of each other
• Many examples of lobbying efforts by MNCs for policies in favor of
foreign countries
Operational Impact of FDI

• Technology transferred at prices that are too high or terms too stringent
• Inappropriate technology used
• Maintain key functions/knowledge at home country to perpetuate
dependence of MNCs
• Introduce superfluous products that are not useful to society
• Expatriates have top management positions
Gross Fixed Capital Formation and FDI

• A summary of the total amount of capital invested in factories, stores


office buildings
• The main asset types are plant & machinery, equipment, vehicles, land-
improvements and buildings.
• All things being equal, the greater the capital investment in an economy,
the more favorable its future growth prospects are likely to be.
• FDI helps to develop GFC in countries
• FDI equity flows were US$ 5.5 billion in 2005-06, it increased
almost three times to US$ 15.7 billion in 2006-07, representing a
growth rate of 184 per cent. In fact, calculating the total FDI inflows
into India by international best practices places the total inflow at
US$ 19,531 million.
• This huge inflow of FDI has in turn reversed the past trend, with
FDI inflows overtaking the portfolio investment inflows by almost
US$ 5.6 billion in 2006-07, according to the RBI’s report on
International Investment Position.
• During April-July 2007-08, FDI inflows amounted to US$ 5,614
million as against US$ 2,848 million during the corresponding
period last year, recording a growth rate of 97 per cent.
• The principal sources of FDI during August 1991 to June 2007 have
been Mauritius (US$ 20,808 million), US (US$ 6,215 million), UK
(US$ 3,979 million), Netherlands (US$ 2,789 million), Japan (US$
2,585 million), Singapore (US$ 2,033 million) and Germany (US$
1,917 million), accounting for 41.89 per cent, 12.03 per cent, 7.98
per cent, 5.59 per cent, 5.07 per cent, 4.05 per cent and 3.69 per
cent, respectively.
• The principal sectors attracting FDI during August 1991 to June
2007 have been services (US$ 9,443 million), electrical equipment
(US$ 8,964 million), telecommunication (US$ 4,880 million),
transportation (US$ 3,856 million), fuels (US$ 2,892 million),
chemicals (US$ 2,465 million) and construction (US$ 1,912
million).
Cisco
• Networking major Cisco's CEO John Chambers announced a $1.1 billion
investment package for India. Chambers said that the company is also
considering India as a manufacturing base.
• Intel: Intel Corporation said the company would invest more than $1
billion in the next five years to expand its operations in India and in local
technology companies.
AMD & SemIndia

• SemIndia, a consortium of overseas Indians, plans to invest $3 billion in


an advanced semiconductor manufacturing facility in the country with
technology from America's Advanced Micro Devices Inc.
• SemIndia sees Indian demand for semiconductor chips at $30 billion
each year by 2015.
Automobile sector
• According to Commerce Minister Kamal Nath, India is an attractive
destination for global auto giants like BMW, General Motors, Ford and
Hyundai who were setting base in India, despite the absence of specific
trade agreements.
• The government is also likely to grant special economic zone status and
take a re-look at the tax structure for setting up testing centres and
manufacturing plants in a bid to make India the automotive hub of the
world.
BMW

• German automobile major BMW signed a memorandum of


understanding with the Tamil Nadu government to establish its car
assembly plant at an investment of $38 million in five years. The
German group has selected a site in Mahindra World City in
Maraimalainagar, near Chennai, to set up its assembly plant.
• BMW has selected Chennai as the "best location" for establishing its car
assembly plant with an investment of about Rs 180 crore (Rs 1.8 billion)
in five years.
Toyota

• Global auto giant Toyota is setting up a gearbox manufacturing plant in


India to serve the Asian market. Toyota is planning to invest around Rs
387 crore (Rs 3.87 billion) in collaboration with its mini-vehicle making
arm Daihatsu. The aim is to develop a compact car for the Indian market.
• Besides, Toyota, Honda Motorcycle, Suzuki Motor (Maruti Suzuki) and
Kansai Paints are firming up plans to pump in foreign direct investment
(FDI) of at least $1.5 billion in the next three years.
Automotive component industry
• India's automotive components industry is the most lucrative sector for
foreign direct investments..
• Automotive components manufactured in India are of top quality and
used as original components for vehicles made by such top
international companies as General Motors, Mercedes, IVECO and
Daweoo among others.
• Japanese and British component manufacturers are already operating
joint-ventures in India. American companies which are setting up
plants in India include Delphi (an automotive components division of
General Motors USA), Delco Electronics, Textron and Magna
International of Canada.
Telecom sector

• LG Electronics has invested Rs 900 cr (Rs 9 billion) at Ranjangaon,


Samsung has planned to set up a mobile manufacturing base in India.
• Finnish mobile handset giant Nokia set up a manufacturing plant in
Chennai with an investment of up to $150 million to meet the booming
demand for its handsets in India.
• The Chennai unit will be Nokia's tenth mobile device production facility
globally and will roll out India-specific entry level and mid and upper
end GSM and CDMA handsets.
Is this trend growth-friendly for India?

• At least one out of four people in India live below the international-
defined poverty line of one U.S. dollar a day.

• A ”negative” aspect is that Indian companies are going abroad despite


the fact that there is no dearth of investment opportunities within the
country.
• Ashok Kumar Bhattacharya, managing editor, ”Business Standard”
newspaper, points out that ”despite the apparently insatiable hunger
for investments in India, the government has failed to put in place
non-discretionary, transparent mechanisms for channeling these
investments”.
• Proposed SEZs will create economic hardship because they would
be built on prime agricultural land, without adequate compensation
for farmers, "islands of affluence in a sea of deprivation",
aggravating India's already wide regional imbalances.
• BBC : there is currently no law to deal with foreign investment by
companies that could have links with terrorism. There are also no
bars against firms involved in money and drug laundering.
• The Indian economy has grown by an average of 8 percent a year
four years in a row, making it one of the fastest in the world.
• Manufacturing industry and the services sector have been annually
expanding at 10 percent or faster, agriculture has grown by a meager
1.5-2 percent a year.
• The secular decline in the share of agriculture sector in GDP
continued, with a decline from 24 per cent in 2001-02 to 17.5 per
cent in 2007-08.
Strategic Alliances

• A strategic alliance is an arrangement between two or more


companies to pursue a common business objective.
• 'if you can't beat 'em, join 'em',
• 'join 'em, and you can beat anybody.‘
Wal-Mart’s experience
• Moved into other countries
– Growth opportunities at home were becoming constrained
– Create value by transferring core skills to markets where indigenous competitors lacked those skills
– Preempt other retailers who were expanding globally

• Discovered had to change US model
– Differences in local taste, preferences and local infrastructure
– Change store location, layout and stocking practices
– Keep company’s core strategies and operations – emphasize everyday low prices & realize
operating efficiencies from world class logistics management and information systems

• Benefits – becoming transnational corporation
– Enhanced bargaining power with suppliers
– Ability to transfer valuable ideas from one country to another
– Balance global standardization with local customization
Boeing enlists the support of its Japanese partners to help offset the
high development costs of the next generation of Jumbos

British Airways possesses an extensive network of routes throughout


Europe and North America due to its partnership with its alliance partner,
US Air

With Quantas, British Airways can provide coverage of Australia, Asia and
the Pacific
• Visa and Master Card, traditionally arch rivals, entered into an
alliance with Microsoft. They together created specifications for
secure online transactions oner open networks, the internet, to
prevent payment fraud.

• TNT, an Australian air express firm, and the post offices of Canada,
France, Germany, the Netherlands and Sweden established a joint
venture to get quick entry into these markets and to counter
competition from federal express, DHL worldwide and United
Parcel Service
A complementor

• 'if customers value your product more when they have the other
player's product than when they have your product alone.‘ - Barry
J.Nalebuff and Adam M.Brandenburger, who coined the word 'co-
opetition' to describe the new world of companies working in
alliance.
• Co-opetitors abound in information and communications
technology, because no company, however mighty, can supply from
its own resources all the hardware, software, connections and
distribution that customers require - and it's customer needs that drive
co-opetition.
• Intel and Microsoft are inseparable complementors in the Wintel
Supplier-Customer Alliances

• In supplier-customer alliances, the traditional adversaries stop battling over


price, and play together to streamline the relationship, thus lowering costs and
improving performance.
• The benefits flow to both. Such partnering between customers and suppliers
enables integrating the whole supply chain to achieve great economies and
increase speed
• IBM- business alliances- 1990s with over 20,000 relationships worldwide.
• Pilkington jointly owns float glass manufacture in Latin America with its
deadly European rival, St.Gobain.
• When IBM and Toshiba agreed to invest $1.2 billion in a plant, sited in
Virginia, to make advanced 64-megabit memory chips, the two were already
partners - with each other in a Japanese plant making liquid crystal display
panels, and also with Siemens in a project making the great leap forward into
256-megabit memory chips.
Success factors

• FOCUS AND DIRECTION: Pharmaceutical giants like SmithKline


Beecham have linked arms with relative minnows to enter
unfamiliar fields like biotechnology. SmithKline Beecham's
necessities included tapping into drug-related research fields, like
biotechnology, where it had no position itself.
• Pilkington jointly owns float glass manufacture in Latin America
with its deadly European rival, St.Gobain. Since alliance with a
Japanese competitor was the key to expanding in automotive glass in
the US and other markets
Acquisitions

• Acquisition of Command Cellular Services in Kolkata by Hutchison


from Usha Martin in 2000.
• Acquisition of 79.24% stakes of Aircel, Chennai by Sterling group
from RPG group for Rs. 210 Crores in 2003.
• Acquisition of 48% stakes in Idea cellular by Aditya Birla group
from the Tata group in 2005.
• Acquisition of Hutch services in India by Vodafone in 2006.
• ICICI acquired Bank of Madura : at a time when its own
revenues stood at Rs 2,500 crore (Rs 25 billion) and that of the bank
at Rs 100 crore (Rs 1 billion.
• Heidelberg Cement , a leading German cement manufacturing
company. entered into an agreement for a 50% joint venture with
the Indorama Cement Ltd., situated in Mumbai, originally
possessed by the Indorama S P Lohia Group. Being one of the
best in the world the Heidelberg Cement Company has its bases
in different countries. The Heidelberg Cement Company has two
manufacturing units in India. A grinding plant in Mumbai and a
cement terminal near Mumbai harbor. A clinker plant is coming
up in the state on Gujarat
• Holcim Cement signed an agreement of 14.8% take over with the
Gujarat Ambuja Cements (GACL). With new products, skilled
personnel, superb management, and a outstanding market strategy gives
this tie up good edge over the other competitors. Holcim Cement
Company, the leading cement manufacturing and supplying companies
has a work force of 90,000.The Holcim Cement Company has units in
excess of 70 countries all over the world.
• Italcementi cement - Zuari Cement Limited Italcementi Cement
Company with the help of the Ciments Français, a subsidiary for its
global activities, has acquired shares of the famous Indian cement
manufacturer - Zuari Cement Limited. The acquisition was of 50%
shareholding and the deal was of about 100 million Euros. Italcementi
Cement is the 5th largest cement manufacturing company in the world.
The production capacity of the Italcementi cement company is about 70
million tons in a year. With the construction boom in India the company
looks for a stable future. In 2001 the Italcementi cement entered the
Indian market scenario. It took over the plant of the Zuari Cement
Limited in Andhra Pradesh in southern India. The joint venture earned
revenues of around 100 million Euros and an operating profit of 4
million Euros.
• Lafarge India is the subsidiary of the Lafarge Cement Company of
France. It was established in 1999 in India with the acquisition of the
Tisco and the Raymond cement plants. Lafarge Cement presently has
three cement manufacturing units in India.
Objectives of Session Three

• WTO and its impact on India


• India’s history with WTO, issues India has agreed on, does not agree and
is forced to agree, the reasons why, the stand offs and India’s concerns
• Regional economic integrations, how each develop from stage one to the
most sophisticated level with examples of the same all over the world
Evolution of the
International Monetary System
• Bimetallism: Before 1875
• Classical Gold Standard: 1875-1914
• Interwar Period: 1915-1944
• Bretton Woods System: 1945-1972
• The Flexible Exchange Rate Regime: 1973-
Present
Bimetallism: Before 1875

• A “double standard” in the sense that both gold and


silver were used as money.

• Some countries were on the gold standard, some on the


silver standard, some on both.

• Both gold and silver were used as international means


of payment and the exchange rates among currencies
were determined by either their gold or silver contents.
Classical Gold Standard:
1875-1914

• During this period in most major countries:


– Gold alone was assured of unrestricted coinage
– There was two-way convertibility between gold and
national currencies at a stable ratio.
– Gold could be freely exported or imported.

• The exchange rate between two country’s currencies


would be determined by their relative gold contents.
For example, if the dollar is pegged to gold at U.S.$30 = 1
ounce of gold, and the British pound is pegged to gold at £6
= 1 ounce of gold, it must be the case that the exchange rate
is determined by the relative gold contents:
$30 = £6
$5 = £1
Highly stable exchange rates under the classical gold standard
provided an environment that was conducive to international
trade and investment.
WHY NOT NOW?

– The supply of newly minted gold is so restricted that


the growth of world trade and investment can be
hampered for the lack of sufficient monetary
reserves.

– Even if the world returned to a gold standard, any


national government could abandon the standard.
Interwar Period: 1915-1944

• Exchange rates fluctuated as countries widely used “predatory”


depreciations of their currencies as a means of gaining advantage
in the world export market.

• Attempts were made to restore the gold standard, but participants


lacked the political will to “follow the rules of the game”.

• The result for international trade and investment was profoundly


detrimental.
History

• After World War II


– Create institutions that would eliminate the causes of war.
• Through UN and eliminating the economic causes of war

• Bretton Woods Conference of 1944


– Three institutions formed:
• The International Monetary Fund (IMF)
• The World Bank
• The International Trade Organization (ITO)
Bretton Woods System:
1945-1972

• Named for a 1944 meeting of 44 nations at Bretton Woods, New


Hampshire.

• The purpose was to design a postwar international monetary system.

• The goal was exchange rate stability without the gold standard.

• The result was the creation of the IMF and the World Bank.
• Under the Bretton Woods system, the U.S. dollar
was pegged to gold at $35 per ounce and other
currencies were pegged to the U.S. dollar.

• Each country was responsible for maintaining its


exchange rate within ±1% of the adopted par value
by buying or selling foreign reserves as necessary.

• The Bretton Woods system was a dollar-based gold


exchange standard.
The Flexible Exchange Rate Regime:
1973-Present

• Flexible exchange rates were declared acceptable to the IMF


members.
– Central banks were allowed to intervene in the exchange rate
markets to iron out unwarranted volatilities.

• Gold was abandoned as an international reserve asset.

• Non-oil-exporting countries and less-developed countries were


given greater access to IMF funds.
Current Exchange Rate Arrangements

• Free Float
– The largest number of countries, allow market forces to determine
their currency’s value.
• Managed Float
– About 25 countries combine government intervention with market
forces to set exchange rates.
• Pegged to another currency
– Such as the U.S. dollar or euro (through franc or mark).
• No national currency
– Some countries do not bother printing their own, they just use the
U.S. dollar. For example, Ecuador has recently dollarized.
THE  INTERNATIONAL  BANK  FOR 
RECONSTRUCTION  &  DEVELOPMENT 
(IBRD):
 
The official name for the IBRD &
the International Finance Corporation
is the world bank.

Established in 1945, the World Bank’s


initial goal was to help finance reconstruction
of the war –torn european economies. with the assistance of the
Marshall Plan, the World Bank accomplished this task by the mid
1950’s.
Then the bank adopted the new mission
of building the economies of the world
developing countries.
As its mission has expanded over time,
the world bank created four affiliated
organizations:

1.INTERNATIONAL DEVELOPMENT
ASSOCIATION (IDA)
2.THE INTERNATIONAL FINANCE
CORPORATION (IFC)
3.THE MULTILATERAL
INVESTMENT GUARANTEE AGENCY
(MIGA)
4.THE INTERNATIONAL CENTER
FOR SETTLEMENT OF INVESTMENT
DISPUTES (ICSID).
INTERNATIONAL 
DEVELOPMENT 
ASSOCIATION (IDA)

IDA offers soft loans, loans that


bear some significant risk of not being
repaid. its lending efforts focuses on the
least –developed countries

a typical loan is the us $92 million


provided to improve rural water suppliers
to 1200 villages (total population-4.8
million) in Karnataka.
The  International  Finance 
Corporation (IFC):

IFC was created in 1956 & is


charged with promoting the
development of the private sector in
developing countries acting like as
investment banker. The IFC, in
collaboration with private investors,
provides debt & equity capital for
promising commercial activities
The  Multilateral 
Investment  Guarantee 
Agency (MIGA):

In 1988 the WB affiliate MIGA


was set up to overcome private –sector
reluctance to invest in developing
countries because of perceived political
riskiness.
MIGA encourages direct
investment in developing countries by
offering private investors insurance
against non-commercial risks.
The  International  Center 
for Settlement of Investment 
Disputes (ICSID):
 
ICSID was founded in 1996 to
promote increased flows of
international investments by providing
facilities for the conciliation &
arbitration of disputes between
Government & Foreign investors.

ICSID also provides advice,


carries out research & produces
publications in the area of foreign
investment law.
INTERNATIONAL MONETARY FUND

To ensure that the post-second


world war monetary system would
promote international commerce,
the bretton woods agreement
called for the creation of the IMF
to oversee the functioning of the
international monetary system.
WTO

The WTO is merely a


smoke-screen for
global domination of
multinationals
General Agreement on Tariffs and Trade
(GATT)

• Congress refused to agree to the ITO


– Cede too much sovereignty to an international body.

• General Agreement on Tariffs and Trade—1947


– Provisional agreement for the ITO
– Became the agreement and the organization for establishing
and enforcing, through dispute settlement, the international
trade rules.
The World Trade Organization

• The Uruguay Round (8th)—1984-1995


– established the World Trade Organization
– amended GATT 1947 which became GATT 1994

• Became the World Trade Organization (WTO) on


January 1, 1995
Mission
• Increase international trade by
– promoting lower trade barriers
– providing a platform for the negotiation of trade

• “...In brief, the World Trade Organization (WTO) is the only


international organization dealing with the global rules of trade between
nations. Its main function is to ensure that trade flows as smoothly,
predictably and freely as possible.”
Structure

• Highest level: Ministerial Conference
– Meets at least every two years
– Comprised of countries or customs unions
– Makes decisions on all matters under any of
the multilateral trade agreements
Structure (cont.)

• Second level: General Council
– Handles the daily work of the ministerial conference along
with the Dispute Settlement Body and the Trade Policy Review
Body
– Consists of representatives of all WTO member states
Structure (cont.)

• Third level: Councils for Trade
– Work under the General Council
• Three parts
– Council for Trade in Goods
– Council for Trade-Related Aspects of Intellectual Property
Rights
– Council for Trade in Services
• Six other bodies report to the General Council
– trade and development
– the environment
– regional trading arrangements
– administrative issues.
Structure

• Fourth level: Subsidiary Bodies


– Three bodies
• The Goods Council—11 committees
– agriculture, market access, subsidies, anti-dumping measures,
etc.
• The Services Council
– financial services, domestic regulations and other specific
commitments
• Dispute Settlement panels and Appellate Body
– resolve disputes
– Appellate Body deals with appeals
Principles of Trading

1. Free of discrimination
– Cannot privilege a particular trading partner above others within the
system
– Cannot discriminate against foreign products and services.
2. Tend toward more freedom
– fewer trade barriers (tariffs and non-tariff barriers)
3. Predictable
– trade barriers will not be raised arbitrarily
– markets will remain open.
4. Tend toward greater competition
5. More accommodating for less developed countries
– Give them more time to adjust, greater flexibility, and more
privileges.
Agreements

• Approximately 30 agreements exist

• Agreements are (officially) made by consensus of all member countries


– Finds the most widely acceptable decision
– Time consuming

• In reality, agreements are often made in informal “Green Room” or


“Mini-ministerial” meetings with some nations not being present
Agreement on Agriculture (AoA)
• Domestic support
– Green box- fixed payments for environmental programs
– Amber box- general subsidies
– Blue box- production-limiting subsidies

• Market access
– Developed countries- reduce tariffs by 36%
– Developing countries- reduce tariffs by 24%

• Export subsidies
– Reduce tariffs by 35%
General Agreement on Trade in Services
(GATS)

• Prior to the GATS there was no agreement with regard to trade in


services

• Historically many services (e.g. health, education) have been considered


the responsibility of government

• With GATS many services have opened up to international trade that


were previously monopolized by governments
Trade-related Aspects of Intellectual
Property Rights (TRIPs)

• Sets forth minimum intellectual property standards for member countries

• Protected items include copyrights, geographical indications, industrial


designs, chip designs, patents, trademarks, trade dress, and confidential
information
Sanitary and Phyto-Sanitary Agreement
(SPS)

• Sets food safety standards


– Bacterial contaminants
– Pesticides
– Inspection and labeling

• Animal and plant health


– Imported pets
– Diseases
Agreement on Technical Barriers to
Trade (TBT)

• Ensures “that technical negotiations and


standards, as well as testing and certification
procedures, do not create unnecessary
obstacles to trade”
Doha Round

Began November
2001
WTO @ Cancun
Hong Kong

• Billed as a “Development Round”


• Agreement to phase out all agricultural export subsidies by 2014
• Terminate cotton subsidies by 2007
• Developing nations again see this round as a loss.
WTO Advantages
• Helps trade to flow smoothly.
• Deals with disputes over trade.
• Decisions in the WTO are made by consensus and the agreements apply
to everyone.
• All countries can appeal against decisions which they feel are unfair.
This system has the potential to protect developing countries from harsh
measures and unfair rules.
WTO Criticisms
1. The WTO only serves the interests of multinational corporations and
wealthy nations.
2. Fundamental principals and aims of the WTO are not beneficial for all
parties involved.
3. The WTO tramples over labor and human rights
4. The WTO is destroying the environment.
5. Fundamental principals and aims of the WTO are not beneficial for all
parties involved.
6. The US adoption of the WTO undemocratic.
7. The WTO undermines local development and penalizes poor
countries.
8. The WTO is increasing inequality.
“Some examples of this bias are: (1) rich countries are able to maintain
high import duties and quotas in certain products, blocking imports from
developing countries (2) the increase in non-tariff barriers such as anti-
dumping measures allowed against developing countries; (3) many
developing countries do not have the capacity to follow the negotiations
and participate actively in the Uruguay Round; and (4) the TRIPS
agreement which limits developing countries from utilizing some
technology that originates from abroad in their local systems.”
- Martin Khor
REGIONAL ECONOMIC
INTEGRATION
Economic Integration
➲ A group of countries come together and agree to cooperate in
international trade by various means.
➲ Mainly economic advantages.
➲ Trade creation and trade diversion, reduced Import Prices, Increased
competition and economies of scale, Higher factor Productivity.
➲ Political Factors and power in international markets.
Levels of Economic Integration.
➲ Regional Cooperation Groups.
➲ Free trade areas.
➲ Full customs union.
➲ Common market.
➲ Economic union.
➲ Political union.
Regional Cooperation Groups.
➲ Cooperate to develop basic industries like steel, hydro-electricity etc.
➲ Joint ventures, pooling of technologies/resources.
➲ Mainly less developed countries.
➲ No effect on trade or tariff barriers.

➲ For Example - A.S.E.A.N.


Brunei, Burma, Cambodia, Indonesia, Laos,
Malaysia, the Philippines, Singapore,
Thailand and Vietnam

➲ The South Asian Association


for Regional Cooperation (SAARC)
Bangladesh, Bhutan, India,
Maldives, Nepal, Pakistan
and SriLanka.

ASEAN
Free Trade Areas.
➲ No Internal Tariffs.
➲ External Tariffs could be different.
➲ Cooperation on economic issues.
➲ No free labor or capital movements.
➲ N.A.F.T.A. --
➲ U.S.-Israel, European Free Trade Area
Full Customs Union.
➲ No Internal Tariffs.
➲ Common External Tariffs.
➲ No Free labor or
capital movements.
➲ Usually a small country
close to a large one.
➲ France-Monaco
➲ Italy-San Marino.
Common Market.
➲ No Internal Tariffs.
➲ Common External Tariffs.
➲ Free flow of labor and capital.
➲ Southern Cone Common Market
(Mercosur) - Argentina, Brazil,
Paraguay, Uraguay, Bolivia,
and Chile.
➲ Caribbean Community
and Common Market.
Economic Union.
➲ No Internal Tariffs.
➲ Common External Tariffs.
➲ Free flow of labor and capital.
➲ Integration of economic policies.
➲ Harmonize monetary policies, taxation, and government spending.
➲ Common currency or fixed exchange rates.
➲ E.U. - Full monetary union by 1999 and single European currency by 2002.
Political union

Political union
– Involves complete political and economic integration, either
voluntary or enforced.
– Commonwealth – a voluntary organization providing for the loosest
possible relationship that can be classified as economic integration.
– Two new political unions came into existence in the 1990s:
• The Commonwealth of Independent States (CIS)
• The European Union (EU)
EU Institutions.

• The European Commission - Executive branch, commissioners oversee


23 directorates such as agriculture, transportation, etc.
• Council of Ministers- votes based on country size, final power to decide
EU actions.
• European Parliament - 626 members elected by popular votes in member
countries, advisory body with very little power.
• European Court of Justice - Judicial branch, mainly matters related to
trade and business disputes.
The Commonwealth of Independent States
• The remaining 12 republics of the former USSR after the
aborted coup against Gorbachev and the formation of the
Baltic States.
• The CIS is a loose economic and political alliance with open
borders but no central government.
• The 12 members of the CIS share a common history of central
planning, and their close cooperation could make the change
to a market economy less painful, but differences over
economic policy, currency reform, and control of the military
may break them apart.
Commonwealth of Independent States
(CIS)
• Exhibit 10.6
Latin America.
• Economic and trade liberalization.
• Deregulation, Privatization and control of inflation.
• Almost every country in Latin America has either signed some type of
trade agreement or is involved in negotiations.
• Latin American Integration Association
• Caribbean Community and Common Market (CARICOM)
• NAFTA to FTAA or SAFTA?
Far Eastern Market Group

• Insert Exhibit 10.9


APEC - Asia Pacific Economic
Cooperation
The Asia-Pacific Economic Cooperation
forum is a loose grouping of countries
bordering the Pacific Ocean who have
pledged to facilitate free trade and economic
cooperation

• Its 21 members
range from China
and Russia to the
United States, Japan
and Australia,
and account for 45%
of world trade.

03/09/98
Africa

• The Economic Community of West African States (ECOWAS) and


the Southern African Development Community (SADC) are the two
most active regional cooperative groups.

– ECOWAS continues to be plagued with financial problems,


conflict within the group, and inactivity on the part of some
members.

• The Southern African Development Community is the most


advanced and viable of Africa’s regional organizations.
Middle East

• Economic Cooperation Organization (ECO)

• Creation of the Organization of the Islamic Conference


(OIC)
– Represents 60 countries and over 650 million
Muslims worldwide
– The member countries’ vast natural resources,
substantial capital, and cheap labor force are seen as
the strengths of the OIC.
OPEC

• The Organization of the Petroleum Exporting Countries (OPEC) is a


permanent, intergovernmental Organization, created at the Baghdad
Conference on September 10–14, 1960, by Iran, Iraq, Kuwait, Saudi
Arabia and Venezuela. The five Founding Members were later joined by
nine other Members: Qatar (1961); Indonesia (1962); Socialist Peoples
Libyan Arab Jamahiriya (1962); United Arab Emirates (1967); Algeria
(1969); Nigeria (1971); Ecuador (1973–1992); Gabon (1975–1994) and
Angola (2007).
OPEC

• OPEC was to rival the supposedly seven sister multinational oil


companies because developing country oil exporters sensed that they
were being exploited by Western governments and their multinational
corporations, who drilled their oil and marketed it as well.
• OPEC’s objective was to co-ordinate and unify petroleum policies
among Member Countries, in order to secure fair and stable prices for
petroleum producers; an efficient, economic and regular supply of
petroleum to consuming nations; and a fair return on capital to those
investing in the industry.
• In 1973 the U.S. and the Western world were
caught in the whorl of inflation and this made
them vulnerable to commodity cartels.
• The preceding twenty years had seen prosperity
and increase in the growth of population, which
created heavy demand for raw materials.
• In the U.S., consumer prices were rising at an
average rate of 8.5 per cent, with even higher
inflation rates in other countries.
• The oil sold by the Gulf nations had therefore
much more demand than before and had grown
beyond the capacity of supply and oil production.
• When President Nixon put controls on oil, the U.S., which had been self sufficient in energy till
the year 1950, was importing 35 per cent of its energy needs in March 1973.
• The so far discovered petroleum reserves of the US were almost depleted. On October 6, 1973, on
the Jewish holy day of Yom Kippur, Egyptian forces attacked Israel from across the Suez Canal.
• Simultaneously, Syrian troops attacked the Golan Heights in a surprise manouvre. Israel, was
supported by the US in their effort, which was disliked by the countries of the OPEC. On October
17, OPEC imposed an oil embargo on the U.S. and increased prices by 70 per cent to America's
Western European allies.
• This raised the price of a barrel of oil to these nations from USD 3 to USD 5.11 and it was further
raised to USD 11.65.
The functioning of oil markets

• The major markets are in London, New York and


Singapore but crude oil and its refined products, such as
gasoline (petrol) and heating oil are procured and put on
the market all over the world. Crude oil is found in several
ranges and qualities, classified as per its specific gravity
and sulphur content. The variety and quality also depends
on where the crude oil has been drilled from.
• Brent is used to price two thirds of the world's internationally traded
crude oil supplies as per IPE reports. Dubai crude is used as a
benchmark to price sales of other regional crudes into Asia in the
Gulf region
• In the United States, the benchmark is West Texas Intermediate
(WTI) meaning, crude oil sales into the US are usually priced in
comparison to WTI. Crude oil prices on the New York Mercantile
Exchange normally refer to light, sweet crude, which may be any
US domestic or foreign crudes but will have a specific gravity and
sulphur content within a certain range.
• The basket price index is currently composed of the following 11
OPEC crude oils: Algeria's Saharan Blend, Indonesia's Minas, Iran's
Iran Heavy, Iraq's Basra Light, Kuwait's Kuwait Export, Libya's Es
Sider, Nigeria's Bonny Light, Qatar's Qatar Marine, Saudi Arabia's
Arab Light, United Arab Emirates' Murban and Venezuela's BCF
17.
Who's in the dock for the
financial turmoil?

Several categories of
individuals and institutions
stand accused.
SUB-PRIME LENDERS

• The root of much of the current difficulties lies in the sub-prime loans
market, predominantly in the US. The sub-prime category refers to the
category of borrowers at the highest risk of defaulting on their loan -
perhaps those with a poor credit history or unreliable income.
• "The poorest people pay the highest interest rates," he says. In the low
interest rate years after 2001, sub-prime borrowers might pay two or
three times the interest of a prime borrower.
• And if some defaulted, it wasn't the end of the world.
Property prices were rising so fast in the US that the odd
repossession wasn't a major problem. In an atmosphere of
speculation, many people saw there was money to be made
in property and so the spiral continued.

• But when the housing market took a turn for the worse, the
problems started. Many borrowers were on deals that for the
first two years had low rates and then switched to a much
higher rate. Once house prices fell, borrowers who were
struggling started defaulting on loans. Repossessed houses
flooding onto the market caused a vicious circle.

• By April this year, the FBI was already investigating 19


allegations of corporate fraud relating to sub-prime loans.
THE INVESTMENT BANKS-
Architects of their own misery?

• If it was just a case of sub-prime lenders suffering a rash of defaults,


then the layman might assume that the damage would be limited to those
lenders - like IndyMac and New Century - that have collapsed.

• But these sub-prime loans were parcelled up and turned into complex
financial products traded on markets all over the world. The esoteric
nature of some of the products related to these loans has been blamed by
many for the extent of the crisis.
WHAT IS SHORT-SELLING?

• Short seller borrows share


• Sells share on market
• Share price falls
• Short seller repurchases share
• Share returned to original owner
• The price difference is mostly profit
A short seller effectively bets on the price of an asset, often a
share, falling. Typically this is done by borrowing the share from
the owner. The share is then sold and when the price drops it is
repurchased and returned to the original owner. The short seller
pockets the difference.

A key issue is the opacity of the banking system. If no-one can truly
assess the liabilities of a given financial institution, how can they
confidently lend it money? But this has helped people make
money.
THE GREAT DEPRESSION 
1929

Photos by photographer Dorothea Lange


THE NATION’S SICK ECONOMY

As the 1920s advanced, serious problems threatened the


economy while
Important industries struggled, including:

• Agriculture
• Railroads
• Textiles
• Steel
• Mining
• Lumber
• Automobiles
• Housing
• Consumer goods
FARMERS STRUGGLE

• No industry suffered as much 
as agriculture
• During World War I 
European demand for 
American crops soared
• After the war demand 
plummeted
• Farmers increased production 
sending prices further 
downward

Photo by Dorothea Lange


CONSUMER SPENDING DOWN

• By the late 1920s, American 
consumers were buying less
• Rising prices, stagnant wages 
and overbuying on credit were 
to blame
• Most people did not have the 
money to buy the flood of 
goods factories produced
GAP BETWEEN RICH & POOR

• The gap between rich and 
poor widened
• The wealthiest 1% saw their 
income rise 75%
• The rest of the population 
saw an increase of only 9%
• More than 70% of American 
families earned less than 
$2500 per year

Photo by Dorothea Lange


THE STOCK MARKET 

• By 1929, many Americans had 
invested in the Stock Market
• The Stock Market had become 
the most visible symbol of a 
prosperous American economy
• The Dow Jones Industrial 
Average was the barometer of the 
Stock Market’s worth 
• The Dow is a measure based on 
the price of 30 large firms 
STOCK PRICES RISE THROUGH 
THE 1920s

• Through most of the 1920s, 
stock prices rose steadily
• The Dow reached a  high in 
1929 of 381 points (300 points 
higher than 1924)
• By 1929, 4 million Americans 
owned stocks 

New York Stock Exchange


SEEDS OF TROUBLE

• By the late 1920s, problems 
with the economay emerged
• Speculation: Too many 
Americans were engaged in 
speculation – buying stocks & 
bonds hoping for a quick profit
• Margin: Americans were 
buying “on margin” – paying a 
small percentage of a stock’s 
price as a down payment and 
borrowing the rest

The Stock Market’s bubble was


about to break
THE 1929 CRASH

• In September the Stock Market 
had some unusual up & down 
movements
• On October 24, the market took 
a plunge . . .the worst was yet to 
come
• On October 29, now known as 
Black Tuesday, the bottom fell 
out
• 16.4 million shares were sold 
that day – prices plummeted
• People who had bought on 
margin (credit) were stuck with 
huge debts
By mid-November, investors had 
lost about $30 billion
THE GREAT DEPRESSION

• The Stock Market crash 
signaled the beginning of the 
Great Depression
• The Great Depression is 
generally defined as the period 
from 1929 – 1940 in which the 
economy plummeted and 
unemployment skyrocketed
• The crash alone did not cause 
the Great Depression, but it 
hastened its arrival
FINANCIAL COLLAPSE

• After the crash, many


Americans panicked and
withdrew their money
from banks
• Banks had invested in
the Stock Market and lost
money
• In 1929- 600 banks fail
• By 1933 – 11,000 of the
25,000 banks nationwide Bank run 1929, Los Angeles
had collapsed
GNP DROPS, UNEMPLOYMENT 
SOARS

• Between 1928-1932, the U.S. 
Gross National Product (GNP) 
– the total output of a nation’s 
goods & services – fell nearly 
50% from $104 billion to $59 
billion
• 90,000 businesses went 
bankrupt
• Unemployment leaped from 3% 
in 1929 to 25% in 1933
CAUSES OF THE GREAT 
DEPRESSION

• Tariffs & war debt 
policies
• U.S. demand low, despite 
factories producing more
• Farm sector crisis
• Easy credit
• Unequal distribution of 
income
Will
History repeat
itself…. ?
The Mexican Peso Crisis

• On 20 December, 1994, the Mexican government announced a plan to


devalue the peso against the dollar by 14 percent.
• This decision changed currency trader’s expectations about the future
value of the peso.
• They stampeded for the exits.
• In their rush to get out the peso fell by as much as 40 percent.
• The Mexican Peso crisis is unique in that it represents the first
serious international financial crisis touched off by cross-border
flight of portfolio capital.
• Two lessons emerge:
– It is essential to have a multinational safety net in place to
safeguard the world financial system from such crises.
– An influx of foreign capital can lead to an overvaluation in the
first place.
The Asian Currency Crisis

• The Asian currency crisis turned out to be far more serious than the
Mexican peso crisis in terms of the extent of the contagion and the
severity of the resultant economic and social costs.
• Many firms with foreign currency bonds were forced into bankruptcy.
• The region experienced a deep, widespread recession.
Currency Crisis Explanations

• In theory, a currency’s value mirrors the fundamental strength of its


underlying economy, relative to other economies. In the long run.
• In the short run, currency trader’s expectations play a much more
important role.
• In today’s environment, traders and lenders, using the most modern
communications, act by fight-or-flight instincts. For example, if they
expect others are about to sell Brazilian reals for U.S. dollars, they want
to “get to the exits first”.
• Thus, fears of depreciation become self-fulfilling prophecies.
Financial crisis: World
round-up
A look at the regions of the world most
affected by the financial crisis, and what
governments are doing to try to alleviate the
financial turmoil.
JOINT ACTION

The International Monetary Fund said it was ready to lend to


countries hit by the credit crunch, using an emergency funding
mechanism first used in the 1990s Asian financial crisis.

The US Federal Reserve, the European Central Bank, the Bank of


England, and the central banks of Canada, Sweden and Switzerland
took the unprecedented step on 8 October of co-ordinating a half-
point cut in interest rates in an effort to ease the credit crunch.

On 13 October, the 15 countries in the eurozone agreed a joint plan


to guarantee loans between banks, and provide government capital
to protect ailing financial institutions.
Have bail-outs worked in the past?
The US is pinning its hopes on a $700bn 
(£395bn) bail-out of the banking sector.

The plan's supporters argue that it is important to bail out banks - as


opposed to other failing industries - because of the knock-on effects a
bust bank can have on the economy.

Banks can also fail for irrational reasons, which non-financial companies
are less likely to do. A perfectly sound bank could fail just because its
customers panic and all ask for their money on the same day.
US AIRLINE SECTOR 2001
The airline industry faced collapse after the terrorist attacks of 11
September. United was one of the airlines worst affected by 9/11.
Carriers faced immediate problems when a flying ban was imposed and
people were afraid to fly. The US government provided compensation.
But once flights resumed, the airlines faced a problem that is now
familiar to banks: they could not get credit. The government set up the
Air Transport Stabilization Board to provide up to $10bn (£5.66bn) in
loan guarantees. The government received shares in the airlines in return
for guaranteeing loans to them and also charged fees for participating in
the scheme.
"The bottom line is that the programme did its job," says Professor
Leighton Vaughan Williams from Nottingham Business School.
"Taxpayers eventually made a profit of $300m," he adds. It was not an
easy time for airlines and several such as United Airlines were forced to
seek bankruptcy protection, but most of them survived.
THE BRITISH EXPERIENCE 1970s
• Bailing out or nationalising big manufacturers is not as popular as it
once was. Advocates of bail-outs arged that if "a company had a
strong future but was experiencing temporary difficulties, that would
be solved by an injection of taxpayers' money," says Professor Naresh
Pandit from Norwich Business School. "The idea was that the
government could later withdraw, but it never did as planned."

• British Leyland was effectively nationalised with a cash injection in


1975 and, despite owning marquees that still exist today, the company
itself and the British carmaking industry never really recovered.
• Rolls-Royce was nationalised in 1971, a bail-out which worked
better in the long run than the British Leyland deal.

• The company had run into difficulties due to cost-overruns in the


development of its RB211 engine. It spun off its carmaking division
in 1973, but the rest of the company remained in government control
until 1987, when it was privatised. Rolls-Royce is now a successful
company, but many people argue that it spent too long in
government hands. "There is strong evidence that nationalisation
leads to lower efficiency," says Professor Pandit.
SAVINGS AND LOANS 1980s and 1990s

America's savings and Loans companies were similar to building


societies in Britain and were often owned by their customers. The US
Savings and Loan (S&L) crisis of the 1980s and 1990s was partly caused
by institutions lending more money in home loans than was prudent and
then getting hit by rising interest rates, which will sound familiar to
observers of the current crisis. Fraud was also a big factor.
The government set up the Resolution Trust
Corporation (RTC) to take over the hundreds of
failed S&Ls and try to sell their assets. "The
bail-out cost about $300bn in today's money
and when the RTC sold the assets, it made back
about 80% of what it paid," says Professor
Vaughan Williams. "To get back 80% on what
were bankrupt assets could be called a success."
THE EARLY BAIL-OUTS 1792

Bailing out banks is certainly not a new idea, with the first US bank
bail-out taking place in 1792. William Duer tried to corner the market
in government bonds and depress the share price of the Bank of New
York. His plan went wrong, causing market panic.

With the value of bonds collapsing, the first Treasury Secretary


Alexander Hamilton told banks to accept bonds as collateral for loans,
which were then underwritten by the government. He also borrowed
money from banks and used it to buy government bonds. Prices
recovered and all the banks involved survived.
In marked contrast, President Andrew Jackson in the 1830s was
widely blamed for bringing about the demise of the Second Bank of
the United States when he refused to deposit tax revenues in it.

The collapse of the bank was one of the causes of the Panic of 1837
in which the next president, Martin van Buren, refused to involve
the government. Milton Friedman described the depression that
followed as the only one comparable with the Great Depression of
the 1930s.
What do market moves
mean for you
• Traders are not the only ones worried about the falls. The
fluctuations of share prices affect all of us - often in a more direct
way than consumers realise.

• At the start of trading on Friday the FTSE 100 share index plunged
about 10%, falling below 4,000 points for the first time in five years.

• There were also falls across the world - in France, Germany,


Australia, Hong Kong, Singapore and Russia, as well as in Tokyo
and on Wall Street.
• The "ripple effect" of a downturn in the market has an effect on house prices,
says Mr Halling.

• As well as traders becoming less wealthy and so less likely to buy homes, the
shrinking possibility of borrowing and less job security also slows down the
housing market.

• In recent years, employees might have been paid bonuses in shares. People
might have held onto shares handed out to customers when building societies
demutualised in the late 1990s.
• Any share-based investments such as shares ISAs or endowment policies will have
been cut in value. There are worries for people who use endowment policies to pay
off their mortgage.

• But trying to cash them in early will cost you money.

• It is always worth remembering that investments are very different from savings in a
bank account - they can go down in value as well as up, especially in the short-term.

• Perhaps most affected by this latest slump are those who are set to retire soon.
What about pensions?

• Some 60% of an average pension fund is invested in shares.

• People with personal pensions and on the cusp of retirement will be


pulling money out of the stock market in order to buy an annuity - your
income in retirement.

• Tom McPhail, head of pensions research at Hargreaves Lansdown, says


that those buying an annuity now will have an annual sum until death
that is 15% less than it would have been a month ago.
• This could lead people to delay their retirement.

• The latest you can leave it to buy an annuity is the age of 75. The government says it may
consider a temporary suspension of this deadline so people of that age can wait for their
funds to recover.

• Others have pensions in a final salary scheme. They are safe because their employer covers
the risk.

• But over the long-term, if the markets continue to struggle, employers may be quicker to
close down these schemes to new members.
Any other long-term effects?

• Children born in the UK after September 2002 have a nest-egg being


saved for them in Child Trust Funds.

• These funds, which began operating in April 2005, will now probably be
worth less than they were if they haven't been topped up by parents. But
youngsters cannot get their hands on them until they are 18, and so by
then they may have grown in value.
Is that the same with all investments?
• Financial advisers always say that investments should be for the long term even though, as Dane
Halling says "we do not know what is on the other side of the valley". Most people's funds are spread
across a series of stocks in order to protect them if one plunges further than others.

• Jason Butler says that people can "rebalance" where these funds are invested, but ultimately they will
recover if investments are left for a number of years. He points to the experiences of the late 1970s.
If somebody invested £100 in shares on the London Stock Exchange in 1973, it would have only
been worth £34 by the end of 1974.

• But around four years later it would have been back in positive territory and by 1982, it would have
been worth £300. "It is the fool who jumps," says Mr Butler.

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