INTERNATIONAL CAPITAL MOVEMENTS AND MULTINATIONAL CORPORATION A.

Introduction It is a well known fact that economic liberalization all over the world, particularly since the late 1980s, has tremendously contributed to the mobility of capital across the countries. The assumption of the classical economists that there is factor immobility between the countries has been proved to be unrealistic. This is particularly so as for as the mobility of capital is concerned. Foreign capital and technology play a crucial role in the socio-economic development of a country. In the last twenty years, the world has witnessed sea changes in the international movement of capital especially though the Multinational Corporations. International investments have become the order or the day all over the world and have become powerful driving force behind the economic development of many countries. International economic integration has been facilitated by tremendous cross-border flows of capital, both private and official. Economic reforms and the far-reaching changes in the political scenario have brought about substantial changes in international capital flows. The importance of international capital flows could be summed up by quoting the well known management experts, Peter Drucker. Accor4ding to him, . Increasingly world investment rather than world trade will be driving the international economy. This chapter focuses attention on the role, types, determinants and limitations of international capital flows and examines the part played by the Multinational Corporations in the developing economies. B. Role of International Capital Flows International capital flows or movements, in their diverse forms, have been the catalyst of worlds economic development. The role of international capital movements is clear from their advantages explained below: 1. Internationalization of the World Economy: In the first place, international capital flows have been largely contributing for the internationalization of the world economy. This has been possibly by the impact of foreign capital on business environment. The massive inflow of international capital has led to a significant increase in global production, employment and trade. All this has considerably contributed to the internationalization of the world economy. Undoubtedly, the opening up of economies has been encouraged by international capital inflows. 2. Advantages to Domestic Labour: International investment is considered to be a boon to domestic labour on the following grounds: (i) Domestic labour will have many employment opportunities (ii) There may be an increase in real wages because of the increase in productivity. (iii) There will be improvements in the working conditions (iv) The productivity of labour may improve because of the adoption of better technology 3. Advantages of Consumers International movements of capital and investment favour the consumers in following ways: (i) By reducing costs, product prices will be lower (ii) Quality of products will be better (iii) Consumers will bet new products (iv) Consumers gain by the increase in competition 4. Benefits to Government The increase in production and foreign trade will increase the revenue of the government. Besides, international investment on basic industries, infrastructure etc, will reduce the responsibility and the burden on the government. 5. Creation of External Economies Foreign investment made on infrastructure will create external economies. This will go a long way in reducing investment in the host country by domestic investors.

6. Spillover Benefits The spillover benefits of international investment consist of the following: (i) Availability of up-to-date technology. (ii) Enhancement of a variety of skills (iii) Higher efficiency of domestic financial markets. (iv) Improved resource allocation. (v) Efficient financial intermediation and others. 7. Containing inflationary pressures By increasing output and helping to import food grains and other essential commodities, foreign capital helps to contain inflationary pressures in the developing economies. 8. Favorable effects on balance of payments The inflow of foreign capital helps to fill in the gap or deficit in the balance of payments of the less developed countries. Besides, it helps to augment of foreign exchange reserves of the host country. For example, at present India is one of the largest holders of foreign exchange reserves. 9. Engine of Economic Growth In the context of economic development, the role of foreign capital is quite crucial. Because of the limitations of domestic saving and investment, less developed economies have to depend on foreign capital for accelerating economic growth. It may be mentioned here that China has been able to maintain a high GDP growth rate for along time, thanks to the massive inflow of foreign direct investment. 10. Introduction of new culture and value-system Another advantage of international flow of investment relates to the introduction of new culture and value-system in the host countries. There will be stress on hand work, discipline, innovativeness etc. C. Limitations and Dangers of International Capital Flows Despite its many advantages, international investment has its own limitations and shortcomings which are as under: 1. Low absorptive capacity The capacity of the less developed countries to absorb foreign capital is limited on account of the following factors: Lack of infrastructure. Lack of proper technology. Lack of adequate and skilled personnel. Inefficient administrative machinery etc. 2. Foreign Capital Not Necessary Some economists argue that foreign capital is not a pre-condition for economic development. Many countries, like the former Soviet Union, have attained economic development without foreign aid. In other wor4ds of Prof, Barrer .If the main springs of development are present, material progress will occur even without foreign aid. 3. Risk of Dependence Dependence on foreign aid poses many risks because of uncertainty. This is so particularly so when the relations between the countries concerned are strained. 4. Unsuitable Technology In many cases, technology imported by the less developed countries has proved t o be unsuitable and inappropriate to the needs and conditions of these countries. Western models of development do not hold good to the less developed countries. 5. Problem of Debt Trap Huge and indiscriminate external borrowing has landed many countries in a debt trap. Some countries, like Brazil and Mexico, are compelled to utilize their external debt to service debt. 6. Conspicuous consumption Foreign investment has encouraged production and consumption of luxuries. It has resulted in Demonstration Effect. Hence foreign capital encourages wasteful consumption.

7. Problem of tied-aid The problem of tied-aid is another disadvantage of foreign capital. Under tied-aid, the aid receiving country is compelled to buy goods, machinery etc. from the donor country. On the one hand, the quality of these goods may be poor and on the other hand, prices may be higher. 8. Evils of Multinational Corporations Another danger of international capital flows is the domination of multi-national corporations. These MNCs indulge in many unethical and restrictive trade practices. 9. Investment in High Profit Areas International Capital flows have encouraged investments in high profit areas rather than in priority sectors. International investments have not contributed much to develop infrastructure in the less developed countries. 10. Political Pressures Experience of many countries has proved the dangerous consequences of foreign capital on the political machinery of the host countries. Foreign companies and investors have exerted unfair influence on the working of the governments of the aid receiving countries. Many a time aid has been given with political strings. 11. Adverse effects on Balance of Payments It has been observed that foreign investments have resulted in adverse balance of payments of the host countries. This is because the outflow of capital in the form of royalty, dividend etc, has been much more than the inflow of capital in terms of investment. 12. Destruction of Small-scale and Cottage Industries The entry of multi-national corporations has led to the destruction of the traditional small scale and cottage industries of the less developed countries. Many of these industries are compelled to wind up their activities. 13. Unfavorable effects on culture Critics of foreign capital have pointed out the adverse effects of foreign capital on cultural values and system of the less developed countries. Social relationships have been destroyed by modernization and commercialization. In conclusion, it may be observed that international capital flows have both positive and negative effects on both the donor and the host countries. What is important is that the host countries should exercise some controls over foreign investment and at the same time create a condusive environment for the inflow of foreign capital. Foreign investment or aid, cannot be totally done away with. D. Types of International Capital Flows The various channels of international capital flows are classified as under: 1. Direct and Indirect capital 2. Home and foreign capital 3. Government and private capital. 4. Short term and long- term capital. 5. Foreign Aid What follow is an explanation of the above types of international capital flows: Foreign capital may assume two forms: (a) Foreign Direct Investment (FDI) (b) Indirect or Portfolio Investment (a) Foreign Direct Investment (FDI) Foreign Direct Investment (FDI) refers to investment in a foreign country where the investor retains control over investment. It takes the following forms: (i) Setting up of a subsidiary (ii) Acquiring a stake in an existing firm (iii) Starting a joint venture in a foreign country The distinguishing feature of FDI is that investment and management of the firm concerned normally go together. FDI is the sum total of equity capital, re-investment of earnings, other short-term and long-term capital as shown in the balance of payments.

Foreign Direct Investment assumes the following forms: (a) Greenfield investment (b) Cross-border Mergers and Acquisitions ( M and As) (c) Joint ventures Greenfield investment occurs when the investing firm establishes new production, distribution or other facilities in the host country. FDI may occur in the form of an acquisition of, of a merger with, an established firm in the host country. Finally, FDI may assume the form of joint ventures with a host country firm or with a government institution, as well as with another company that is foreign to the host country. Demerits of Foreign Direct Investment Foreign Direct Investment is influenced by the following factors: Rate of return on the project concerned. Return and risk Market size. Firm-specific advantages Need for internationalization International immobility of factors of production The role of product cycle The role of oligopolistic reaction The role of internal financing The effect of exchange rates The role of political risk and country risk. The role of tax policies The effect of trade barriers The effect of government regulations etc. Advantages and disadvantages of FDI The advantages and disadvantages of Foreign Direct Investment could be analyzed with reference to the host and home countries. 1. Advantages (A) To the Host Country The following are the main advantages of FDI to the host country: Availability of scarce factors of production Improvement in the balance of payments Building of economic and social infrastructure Fostering of economic linkages Strengthening of government budget. (B) To the Home Country Availability of raw material. Improvement in balance of payments. Employment generation Revenue to the government Improved political relations II. Disadvantages (A) To the Host Country Strained balance of payments following reverse flow. Dependence on the import of technology Employment of expatriates Unsuitable technology Unhealthy competition Political interference Investment only in high profit areas Adverse effects on (B) To the Home Country Undesired outflow of factors of production

 Conflict with host country government Hampers home countrys interest. (b) Foreign Indirect or Portfolio Investment (FPI) Foreign Portfolio Investment (FPI) refers to investments by individuals, firms or public bodies in financial instruments like shares, bonds or other securities abroad. These investments, which can be liquidated fairly easily, are influenced by short-term gains. Again, these investments are generally more sensitive than direct investments. Further, portfolio investors do not have direct involvement with the promotion and management of the enterprise. The following are the various alternative investment vehicles for foreign equity investment: Direct purchase of securities in overseas markets The use of American Depository Receipts Single country funds International funds Global funds Since 1980s FPI has witnessed spectacular growth because of the following factors: (i) Deregulation of financial markets (ii) Desire of international investors to improve performance (iii) Advent of floating exchange rates (iv) Modernization and increased competitiveness of stock exchange (v) Development of technology and online trading (vi) Expanded pool of liquidity. (2) Home and Foreign Capital The distinction between home and foreign capital is made with reference to balance of payments entries. Home capital means investments made abroad by residents of the country concerned. Foreign capital, on the other hand, refers to outflow of capital, foreign capital refers to inflow of capital. (3) Government and Private Capital International capital flows are also classified into Government (public) and Private capital flows. Public foreign capital may take the following forms: (i) (ii) (iii) (iv) Granting of bilateral loans by the government of one country to the government of another country. Granting of bilateral soft loans as for example, sale of food grains by the United India to India under PL 480 programme Multilateral loans like Aid India Club, Aid Pakistan Club etc Loans made by international monetary institutions like the IMF, World Bank, ADB etc.

Private Capital movements consist of Foreign Direct Investment and Foreign portfolio Investment. Private Capital flows are induced by profit motive. (4) Short-term and Long-term Capital Short-term capital flows will be for a period of less than one year. These capital movements are mostly speculative in nature. Sometimes, short-term capital movements take the form of hot money movement which refers to the movement of capital to take advantage of the international differences in interest rates. But this hot money movement could be destabilizing. Short-term capital movements, of the normal type, generally take the form of commercial bank deposits, over-drafts, bills of exchange etc. Long-term capital movements consist of long-term investments assuming the following forms. (i) (ii) Purchase of equity shares or bonds by private corporations or individuals in another country. Loans from international monetary institution like the IMF, World Bank etc.

(5) Foreign Aid The term foreign aid, in its broader sense, refers to all kinds of foreign assistance including private foreign capital, technical assistance, personnel assistance etc. In its narrow sense, foreign aid means unilateral payments, like gifts and grants, which need not be repaid. The features of foreign aid, in this sense, are:

The aid is given usually by the advanced countries to the less developed countries for development programmes. The aid is given by international organizations also. The aid is generally given for specific purpose and the recipient country has to use it (aid) for the purposes also. E. Factors Affecting International Capital Flows The flow of international capital or investment is influenced by a variety of factors which is explained below: (1) Rate of Interest: Economists like Bertil Ohlin have stressed the importance of the rate of interest as a determinant of international capital flows. Rate of interest is regarded as one of the most important stimuli to international capital flows. Other things being the same, capital tends to move from a country where the rate of interest is low to a country where the rate of interest is high. A country which has a low rate of interest will stand to gain by exporting capital to a country where the rate of interest is high. (2) Speculation: Speculation has an important role to play in short-term capital movements. Speculation may relate to either the expected change in the interest rate of anticipation of change, in the exchange rates. When a country expects a rise in interest rate in future, it will expect an outflow of capital for the present. On the contrary, if a country expects a fall in the rate of interest in future, it will experience an inflow of capital for the present. Capital movements are influenced by the anticipation of devaluation and revaluation of currencies which lead to changes in exchange rates. (3) Profitability: Profitability or return on investment is an important determinant of international capital flows or investment. Other things remaining the same, private capital will be attracted to countries where the return on investment is higher. This is particularly so in the caste of long-term investment. (4) Costs of Production: If the cost of production is lower in the host country, foreign investment will be encouraged. Foreign investment tends to flow to those countries where wages are low and the prices of other inputs are comparatively lower. (5) Bank Rate: A rise in the bank rate by the central bank will attract foreign capital to the country concerned and prevents the flight of capital. On the other hand, a reduction in the bank rate will have the opposite effect. (6) General Economic Conditions: International Capital flows are influenced by general economic conditions and factors in the host countries concerned. These factors include the following: Size of population Level of income Size of the market Development of infrastructure Growth of banks and other financial institutions Availability of skilled labour General business conditions etc. (7) Commercial Policy: Another important factor influencing international capital flows is the foreign trade policy of the country/countries concerned. A policy of trade liberalization or free trade will encourage international capital movements while a policy of protection will have adverse effect on international investments. (8) Economic Policies of the Government : International capital flows are influenced by the following economic policies of the government: Tax policy Policies towards foreign capital and investment Monetary policy Policies regarding repatriation of profit, dividend, interest etc. (9) Political factors : Political factors which affect international capital movements consist of the following: Existence of peace, law and order

Political stability Security of life and property Immigration rules and regulations Non-discriminatory treatment to foreigners Attitude of the host countrys people towards foreigners. Efficiency of bureaucracy. (10) General Business Conditions: International investments depend upon investment opportunities available in the host country / countries. If the host country is expiring a phase of boom it will attract foreign investment. But during a period of depression, foreign capital cannot be attracted. It may be noted that international capital movements are influenced not only by the conditions and economic and political policies of the home country also influence international capital flows.

MEANING, ORIGIN AND GROWTH OF MULTINATIONAL CORPORATIONS (MNCs) A. Meaning: There is no universally accepted definition of the term Multinational Corporation. Anyhow, some of the definitions of an MNC are as under: According to ILO Report, The essential nature of the Multinational Enterprise lies in the fact that its managerial headquarters are located in the country (referred to for convenience as the home country) while the enterprise carries out operations in a number of other countries as well (host countries). It means a corporation that controls production facilities in more than one country, its multinational in nature. In the opinion of James C.Baker, a multinational company is one; (a) Which has a direct investment base in several countries; (b) Which generally derives 20 percent to 50 percent or more of its net profits from foreign operations; and (c) Whose management makes policy decisions based on the alternatives a available anywhere in the world. In India, according to Foreign Regulation Act, 1973, (FERA) a multinational corporation is one, which (i) (ii) Is a subsidiary or a branch or has place of business in two or more countries or territories. Carries business or otherwise operations in two or more countries or territories.

Thus, a MNC may be defined as an enterprise which operates in a number of countries and which has production and service facilities outside the country of its origin. In simple words, a MNC owns and controls assets in more than one country. B. Features of MNCs : The following are the salient features of multinational corporations: 1. MNCs have their managerial headquarters in home countries and carry out operations in home countries and carry out operations in a number of other countries. 2. MNCs are usually large-sized and exercise a great deal of economic dominance. 3. They control production activity with huge foreign direct investment in more than one developed and less developed countries. 4. The MNCs are oligopolistic in nature. 5. MNCs control a bulk of global foreign trade. 6. A considerable part of capital assets of the parent company is owned by home countrys citizens. 7. Major investment and other decisions are taken by the parent company. 8. MNC activity falls mainly to the category of Foreign Direct Investment. 9. They are motivated by profit.

It may be noted that terms such as International Corporation, Multinational Corporations, Transnational Corporation and Global Corporations are used synonymously. But there is some distinction between these terms. TOP MULTINATIONA OF THE WORLD Name of the Company Situated at 1. General Motors U.S.A 2. Exxon U.S.A 3. Ford Motors U.S.A 4. General Electric U.S.A 5. International Business Machines U.S.A Corporation (IBM) 6. Mobil OCL Netherlands 7. Phillips Germany 8. Siemens Germany 9. Volkswagen Germany 10. Royal Dutch Shell Britain/ Netherlands

C. Origin and Growth of MNCs Historically, transnational trading was conducted by Greek, Phoenician and Mesopotamian merchants. But gradually Europe and the Middle East stepped into feudalism following the fall of the Roman Empire, consequently, trade between nations became difficult. Later on, merchants of Italy established commerce and became, therefore, the forerunners of multinational firms. Cities like Genoa, Venice, Florence and others became the supply depots of the traders. As the money economy replaced the barter economy, banks and money lending institutions developed and flourished, leading to active transnational operations. Multinationals, in the form of trading company started in 17th and 18th centuries. Examples include- the Hudson Bay Co., the East India Co., the French Levant Co., etc, Further, export and import houses, commercial and financial institutions emerged and began to flourish. During the 19th century, foreign investment flowed extensively from Western Europe to the underdeveloped areas of Asia, Africa and America, Britain, France, the Netherlands and Germany were the main exporters of capital, British firms made extensive investments in India, Canada, Australia and South Africa. The colonial powers had captive markets and raw material resources to their colonies. During the early years of 20th century6 multinational corporate investment was mainly in mining and petroleum industries. Big oil companies like British Petroleum and Standard oil were the first multinationals in this area. The first world ward encouraged multinational investment, Due to protectionist policies; firms replaced exports with foreign production. Gradually, manufacturing and merchandising multinationals like Unilever Lever Brothers, Nestle, Coca Cola, Singer, Ford Motors and various German drugs and chemical firms, began their operations on a world wide scale. Thus, the concept of multinational enterprise is not new, but the modern multinational corporations are faced on more than just trading. It tries to optimize its international production and marketing often doing so by the use of trademarks and patents. We can witness three important phases in the growth of MNCs. They are: 1. In the First phase which lasted till the First World War, European companies dominated the scene. 2. In the Second phase, covering the decades of fifties and sixties, American multinationals such as General Motors, Ford Motors and IBM emerged on the global scene. 3. The Third phase of growth of MNCs, beginning from 1970s has been dominated by European, German and Japanese multinationals. In recent years, it is interesting to note that multinational corporations have also been produced by developing economies like India, Malaysia, Hong Kong, Singapore, South Korea etc.

At present 90 percent of the top multinational corporations have their headquarters in European Union, Japan and the United States. According to World Investment Report 1997, there were some 45,000 MNCs with around 2, 80,000 affiliates. According to World Investment Report, 2004, there were 61,500 MNCs with over 9.25 lakh foreign affiliates. The MNCs account for a significant share of the worlds industrial investment, production, employment and trade. D. Multinational Corporations and Developing Economies. In the context of the developing economies, the MNCs have a significant role to play, foreign capital plays a key role in accelerating the pace of economic development of the developing economies. The role of MNCs in developing economies is so significant that these countries themselves are establishing MNCs. The following are the top non-financial developing country MNCs. Name of the Company 1. Petroleos Venezuela 2. Jardine M 3. First Pacifric 4. Cemex 5. Sappi Ltd 6. China State Construction 7. China Chemicals 8. LG Electronics Situated at Venezuela Hong Kong Hong Kong Mexico South Africa China China Republic of Korea

E. Role of MNCs in Developing Economies The role of multinational corporations in the developing economies is explained below: (1) Sustaining a High Level of Investment: In the developing economies, there is a gap between savings and investment. This gap has to be filled in through foreign capital. MNCs can help in supplementing domestic savings of the less developed economies. They help to sustain a high level of investment needed for the economic development of these economies. (2) Filling in Technological Gap: In the developing economies, technology is quite backward. It is unable to keep increase productivity. MNCs contribute much to fill in the technological gap in the developing economies by transferring technology. (3) Exploitation of Natural Resources: In the developing economies, natural resources are available in plenty. But they are either unutilized or underutilized for want of proper technology and adequate capital. MNCs help to exploit these resources by providing capital and technology. (4) Undertaking initial risk: Multinational corporations undertake the risk of investment in the host countries and thus provide the much needed impetus to the process of industrialization. This will go a long way in promoting economic development. (5) Creating Social and Economic Infrastructure: In the less developed economies, there is a dearth of social and economic infrastructure like education, health, power, transport and communication etc. Foreign investment in these areas will create external economics and boost domestic investment also. (6) Filling in Foreign Exchange Gap: Multinational corporations help to fill in the gap between foreign exchange earnings and expenditure in the developing economies. By so doing, they help to improve the balance of payments position of these economies. In addition to the above six arguments, the entry and the role of MNCs in developing economies are justified on the following grounds. (a) MNCs help to generate employment opportunities (b) They contribute to the professionalization of management of the enterprise (c) MNCs help to break down domestic monopolies in the developing economies. (d) MNCs act as agent of change and modernization in the less developed economies. (e) They contribute to the development of basic and key industries (f) Again, MNCs help to increase capital formation in the developing economies (g) MNCs offer a wide variety of goods to the consumers of the developing economies.

F. Problems of MNCs in Developing Economies: The activities of the MNCs are looked upon with suspicion and distrust in many of the developing economies. The following are the main problems associated with the working of the MNCs in developing economies. (a) Transfer of inappropriate and unsuitable technology. (b) Inadequate generation of employment opportunities (c) Industrial concentration (d) Investment in high profit areas rather than in priority sectors. (e) Adverse effects on balance of payments (f) Restrictive and unethical trade practices (g) Political interference (h) Threat to national sovereignty (i) Bias in favour of MNCs (j) Bargaining with host governments (k) Cultural problems. In the light of the above problems, there is a need for a proper scrutiny of the working of MNCs in the developing economies. The governments of these economies should exercise sufficient control over the activities of the MNCs. Indiscriminate entry of MNCs to the developing economies should be avoided. At the same time, a proper climate should be created in these economies to attract foreign capital. Despite all their evils, the MNCs do have a positive role to play in the context of the developing economies. G. Advantages of Multinational Corporations Multinational corporations are beneficial to the host countries in the following ways: 1. MNCs provide investment capital to the host countries 2. They contribute to raising the levels of income in the host countries 3. Employment opportunities are generated by the investment of capital 4. MNCs transfer the most up-to-date technology, particularly to the developing economies. 5. By transferring technology, MNCs help to encourage enterprise and improve productivity in the host countries. 6. Again, MNCs help the creation of social and economic infrastructure in the host countries. This will help to create external economies and stimulate enterprise. 7. Multinational corporations help to exploit the precious resources which are lying untapped particularly in the less developed economies. 8. Again, MNCs play a significant role in the process of industrialization of the host countries and thus pave the way for the economic development of these countries. 9. Another advantage of MNCs relates to the different kinds of skills they bring to the host countries. 10. MNCs help the host countries to increase their exports and reduce their imports. All this will have favourable effects on the balance of payments of the host countries. 11. Further, MNCs help to create a managerial revolution in the host countries by professionalizing management. 12. MNCs contribute to equalizing the factor prices around the world 13. The huge resources that the MNCs have their disposal enable them to have efficient and massive research and Development programmes leading to innovations. 14. MNCs have beneficial effect on fostering completion and breaking down domestic monopolies in the host countries. 15. Again, MNCs confer significant advantages in providing efficient marketing services. 16. MNCs are agents of change and progress, helping to create a worldwide economic order based on rationality, efficiency and the optimal use of resources. 17. MNCs integrate national and international markets. 18. MNCs also encourage domestic enterprises. To support their own operations, MNCs may encourage and assist domestic suppliers. 19. MNCs are powerful agents of globalization and liberalization 20. Finally, MNCs bring in modern techniques and values leading to social and psychological transformation, especially in the less developed economies.

H. Disadvantages of Multinational Corporations In spite of their innumerable advantages, MNCs suffer from many evils and drawbacks. The drawbacks of MNCs could be listed under the following heads: (a) Political (b) Sales and marketing (c) Environmental management (d) Technology (e) Personnel management and Industrial Relations (f) Cultural a. Political drawbacks Supporting repressive regimes Paying bribes to secure political influence Not respecting human rights Paying protection money to terrorist groups Destabilizing national governments Interfering in States sovereignties b. Sales and Marketing Undermining ancient cultures and traditions by misleading and unpleasant advertising and marketing methods Promoting goods that waste value resources in less developed countries Supplying products that are inappropriate to local needs Not accepting responsibility for unsafe products c. . Environmental Management Depleting natural resources too quickly Polluting the environment Not paying compensation for environmental damage Causing harmful effects on local living conditions Causing major damage and destruction to environment d. Technology Using and transferring inappropriate technology Charging exorbitant license fees Not encouraging R and D programmes in the host countries Encouraging brain drain from the less developed countries Creating technological dependence for the less developed countries Creating technological dependence for the less developed countries Not allowing locals in the operation of important technology e. Economic Evils Concentrating their operations in urban areas Creating dual economic structures Importing inputs rather than using inputs available in the host countries Repatriation of profits leading to adverse effects on balance of payments of the host countries Dominating key technically advanced sectors Contributing to inequalities in income and wealth distribution Encouraging conspicuous consumption Currency manipulations Evils of transfer pricing Indulging in unfair and unethical trade practices. f. Personnel Management and Industrial Relations Refusing to recognize trade unions Discouraging collective bargaining Using home country staff for key managerial positions Ignoring the occupational health and safety needs of the local workers Exploiting host country labour

 Not involving local employees in decision-making Transferring skills to other countries. g. Cultural Problems MNCs bring their own cultural norms and attitudes to the host country. They have adverse effects on the culture of the host country. They create cultural conflict. I. Suggestions: The following suggestions could be made to check and control the activities of the MNCs: 1. There should not be indiscriminate entry of MNCs 2. Foreign collaborations could be encouraged 3. There should be legislation for preventing the MNCs from taking part in political activities in the host countries. 4. They should undertake R and D programmes in the host countries 5. Equity holding by the MNCs should be restricted 6. There must be a code of conduct to guide and regulate the activities of the MNCs 7. MNCs should respect the national sovereignty of the host countries and observe their domestic laws, regulations and administrative practices. 8. MNCs should disclose relevant information to host countrys government, especially for tax purpose 9. MNCs should follow fair trade practices 10. They should avoid discrimination of any kind especially in personnel matters. In conclusion, it may be noted that if adequate precautions are taken, MNCs can be effective engines of economic development and modernization, particularly in the less developed economies. Questions Section A ( 4 Marks Questions) 1. 2. 3. 4. 5. 1. 2. 3. 4. Explain the types of Capital Movement Write a note on the origin of MNCs What are the advantages of Foreign Direct Investment? What are the disadvantages of Foreign Direct Investment? What are the advantages of MNCs? Section B ( 8 Marks Questions) Explain the types of International Capital Movements Explain the origin and growth of MNCs What are the merits and demerits of MNCs What are the merits and demerits of Foreign Direct Investment? Section C ( 16 Marks Questions) 1. Discuss the various types of International Capital Movement 2. Discuss the factors affecting International Capital Movement 3. Critically examine the role of MNCs in developing economies.

*********************

FOREIGN EXCHANGE RATE - II A. Meaning of Exchange Rate: Transactions in the foreign exchange market take place at exchange rates. The term exchange rate refers to the rate at which the currency of another country. It indicates the exchange ratio between the currencies of two countries. It is the price to be paid for obtaining foreign money. For example, if One U.S Dollar can be exchanged for Rs.40, the exchange rate between the U.S. Dollar and the Indian Rupee will be $1 =Rs.40. There are two methods of quoting the exchange rate of currency. They are 1. One unit of foreign currency to so many units of the domestic currency ; or 2. A certain number of units of foreign currency to one unit of domestic currency It may be noted that in a free foreign exchange market, the exchange rate is determined by the market forces of the demand for and supply of foreign exchange. Therefore, changes in the exchanges in the exchange rate take place because of changes in the demand for and supply of foreign exchange. The demand for foreign exchange arises from the following: (a) Demand for foreign goods and services (b) Investment in foreign countries (c) Other payments involved in international transactions. Thus, the demand for foreign exchange depends on the demand for imports. On the other hand, the supply of foreign exchange depends upon the countrys export goods and services to other countries, foreign investments in this country and other receipts from foreign countries. The equilibrium rate of exchange is determined at the point of the equality of the demand for and supply of foreign exchange. The following diagram illustrates the determination of the equilibrium exchange rate. In the above diagram, Ox axis measures the demand for and supply of foreign exchange. OY axis represents the rate of exchange. DD represents the rate of exchange. SS denotes the supply curve of foreign exchange. P is the point of intersection of demand and supply curves PM or NO is the equilibrium rate of exchange. If the demand for foreign exchange increases the new demand curve for foreign exchange will be DD supply of foreign exchange is assumed to be constant. The increase in the demand for foreign exchange increases, the exchange rate to P M or N O On the other hand, assuming that the demand for foreign exchange remains constant, the new supply curve of foreign exchange is S S . Now the exchange rate falls to P M or N O B. Determination of Exchange Rate In the analysis of determination of exchange rates under the paper currency standard, there are two important theories. They are: 1. Purchasing Power Parity Theory, and 2. Balance of Payments Theory. Now, it is necessary to discuss in detail the above two theories. (1) Purchasing Power Parity Theory: The Purchasing Power Parity Theory seeks to explain the determination of the exchange rate between the currencies of two countries under a system of inconvertible paper standard.

Though this theory was scientifically put forth by the Swedish economist, Gustav Cassel, it mooted first by John Wheatley in 1802. It was refined in 1810 by William Blake and later on by David Ricardo. It was Gustav Cassel who gave a perfect shape to the theory. Before the I world war, many countries were on the Gold standard. Under the Gold standard, the exchange rates were determined by the gold specie points. Subsequently, with the breakdown of the gold standard, many countries adopted a system of inconvertible paper currency standard. There was the problem of the determination of exchange rate under this inconvertible paper standard. It was at this juncture that Cassel came out with his solution the purchasing power parity theory. There are two versions of the purchasing power parity theory. They are: 1. Absolute Version 2. Relative Version 1. Absolute Version: The absolute version of the theory says that under a system of inconvertible paper currency standard, the exchange rate between the currencies of two countries is determined at the point of the equality of the purchasing powers of the two currencies in the respective countries. In the words of Cassel, the rate of exchange between two currencies must stand essentially on the quotient of the internal purchasing powers of these currencies. For example, if a pocket calculator costs $ in U.S.A and Rs.45 in India, the exchange rate between the U.S dollar and the Indian rupee will be $1=Rs.45. The exchange rate will be equilibrium at this rate. Symbolically, Thus, the absolute version of the theory says that the exchange rate will be in equilibrium when the purchasing power of money is equal in both the trading countries. 2. Relative Version: The relative version of the theory maintains that changes in the exchange rate take place due to changes in the purchasing powers of the currencies concerned. Changes in the purchasing powers take place due to changes in the internal price level. Here, some past exchange rate is assumed to be an equilibrium rate and is adopted as the base rate. And as changes in purchasing power can be measured by changes in the indices of domestic prices of the countries concerned, changes in equilibrium rate can be measured by the ratio price indices of the respective countries. Now, the new equilibrium rate can be known by relating the indices of domestic prices in the given period related to price indices in the two countries in the base period to the old equilibrium rate, Symbolically, Illustration The relative version of the purchasing power parity theory can be illustrated with the following example: Let us suppose that in the base year, the exchange rate between the Indian rupee, and U.S dollar is Re 1 = 40 cents. Suppose that in the subsequent period; the price index in India increases to 300 and in the U.S increases to 150, the new exchange rate will be It means that when the price level in country A is doubled relative to prices in B. from the base period to the current period, the exchange rate will fall by half. Criticism: The Purchasing Power Parity Theory is criticized on the following grounds: (1) Unrealistic Assumptions: This theory is based upon certain assumptions which are far from being true in reality. These unrealistic assumptions include perfect competition, free trade etc. (2) Difficulties relating to Index numbers: The purchasing powers are measured with the help of price index numbered. But there are various problems relating to the constructions of these index numbers. (3) Ignores international capital movements: The theory neglects the effects of international capital movements on the exchange rate. (4) One sided Theory: The theory is one-sided because it considers the supply of foreign exchange only, while ignoring the demand side. (5) Neglects Quality of Goods: The theory does not consider differences in the quality of goods as between various countries. Hence, the theory is unrealistic. (6) Overlooks Transport costs: The purchasing power parity theory fails to take of the existence of transport costs in international trade.

(7) Changes in exchange rate influence the price level: According to the theory, changes in the price level or purchasing powers influence exchange rate. But, what is also true is that changes in exchange rates also bring about changes in the price level. (8) Assumption of a Given Exchange Rate: The theory assumes, a given exchange rate, but does not explain how this given exchange rate is determined. (9) Applies to long run only: The theory applies to long-run only. It does not explain short run changes in the exchange rate. (10) Considers merchandise trade only: The theory is unrealistic because it considers only the merchandise trade of the balance of payments. It does not consider other items of the balance of payments. (11) Influence of extraneous Factors: The theory does not consider the influence of extraneous factors like interest rates, government interference etc on exchange rates. (12) Does not consider other factors: The theory takes into consideration changes in the price level only as a determinant of exchange rate. It totally neglects various other factors which influence exchange rates. Merits The following are the merits of the Purchasing Power Parity Theory: 1. The theory stresses the need for maintain internal stability, that is stability of the price level. 2. It throws light on the relationship between internal price level and exchange rates 3. The theory explains the trade situation and the nature of the balance of payments of a country at a particular time. 4. In some degree, the theory holds good to all kinds of monetary standards. 5. The theory makes it clear that relative price levels exert great influence on exchange rate under a system of inconvertible paper currencies. 6. This theory is considered to be the only sensible explanation of long-term changes in the exchange rates.

(2) Balance of Payments Theory Diagram A Diagram B Merits of theory Criticism C. Causes of Fluctuations in Exchange Rates 1. Balance of Payments 2. Inflation 3. Interest Rates 4. Changes in Money supply 5. National Income 6. Resource Discoveries 7. Capital Movements 8. Political Factors 9. Psychological Factors and Speculation 10. Intervention by the Monetary Authorities 11. Technical and Market Factors D. Fixed and Fluctuating Exchange Rates 1. Fixed Exchange Rate System: Arguments for Fixed Exchange Rate System (a) Promotion of International Trade (b) Encouragement to International Investment (c) Correction of BoP Disequilibrium (d) Prevention of the Flight of Capital (e) Preventing Speculation (f) Preventing Competitive Depreciation

(g) (h) (i) (j) (k)

Development of International Financial Markets Support to Regional Arrangements Facilitates Long range planning Important to Small Open Economics Terms of Trade Argument

Arguments against Fixed Exchange Rates: a) b) c) d) e) f) g) h) Sacrifice of Independent Economic Policy Need to maintain huge foreign exchange reserves Transmission of economic disturbances Need for Exchange Control Unsuitable for long run Cost Price relationship Adjustments in Balance of Payments Not permanently fixed 2. Flexible Exchange Rate System Arguments for Flexible Exchange Rate a. b. c. d. e. f. g. h. Smooth Adjustment of Balance of Payments Independent Economic Policy Avoids Trade and Exchange Controls Better Liquidity Better Confidence Gains from Free Trade Cost- Price Relationship Simple System

Arguments against Flexible Exchange Rates: a. b. c. d. e. f. Uncertainty and Risk Speculation Inflationary Bias Adverse Effect of Foreign Trade Competitive Exchange Depreciation Absence of Stable Medium of Exchange

***********************

FOREIGN EXCHANGE MARKET

------ III

A. Meaning: (1) Location (2) Size of the Market (3) 24 Hours Market (4) Efficiency (5) Currencies Traded (6) Physical Markets

B. 1. 2. 3. 4. C. 1. 2. 3. D. 1. 2. 3. 4. 5.

Participants in the Foreign Exchange Market: Corporate Commercial Banks Exchange Brokers Central Banks Functions of the Foreign Exchange Market: Transfer Function Credit function Hedging Function Instruments Traded in Foreign Exchange Market Bills of Exchange Bankers Draft Telegraphic Transfer Mail Transfer (MT) Letter of Credit (LOC)

Advantages to the Exporter: Advantages to the Importer: Disadvantages to the Exporter: Disadvantages to the Importer: Other Means of Foreign Payments: E. Methods of Quoting Exchange Rates: Exchange Quotations a. Direct Quotation Buy Low; Sell High b. Indirect Quotation Buy High; Sell Low F. Concepts of Exchange Rates: 1. Spot Rate and Forward Rate 2. Buying and Selling Rates 3. Merchant Rates 4. Single Rate and Multiple Rate 5. Cross Rates 6. Long rates 7. Tel Quel Rates 8. Nominal, Real and Effective Exchange Rates

G. Foreign Exchange Dealers Association of India ( FEDAI) Functions: 1. Framing Rules 2. Coordination 3. Circulating Information FEDAI Rules:

*************************

FOREIGN EXCHANGE DEPARTMENT OF A BANK --A. Organization and Functions Organisation 1. Dealers - Section 2. Foreign Remittance Section 3. Import Section 4. Export Section 5. Statistics Section B. Functions 1. Purchases and Sale of Foreign Currencies 2. Dealing in Bills of Exchanges 3. Issuing Letters of Credit 4. Providing Credit Facilities a. Export Credit i. Pre-shipment Finance 1. In Rupee Fund Based: Non Fund based: II. In Foreign Currencies ii. Post shipment Finance b. Import Credit 5. Advisory Functions c. Correspondent Banking Services under Correspondent Relationship Case Study of Correspondent Banking in India (1) (2) d. e. Trade Services Treasury Services Account Relations Foreign Currency Accounts

IV

(1) Nostro Account (2) Vostro Account (3) Loro Account f. Handling of NRI Accounts Non Resident Indians (NRIs) Persons of Indian Origin (PIO) Overseas Corporate Bodies (OCB) Non residents (NRs)

Types of NRI Accounts (1) (2) (3) (4) (5) (6) Non-Resident (Ordinary) Rupee Accounts (NRO) Non-Resident Non-Repatriable Rupee Deposit Scheme (NRNR) Non- Resident (External Rupee Accounts (NRE) Foreign Currency ( Non-Resident ) Accounts (FCNR) Resident Foreign Currency Account (RFC) Non-Resident (Special) Rupee Account (NRSR)

Facilities Availabale for NRE/FCNR Account Holders (A) When an Account Holder is still a Non-Resident (B) After the account holder returns to India

EXCHANGE ARITHMETIC AND INTER BANK DEALS A. Ready Exchange Rate for Trade and Non-trade transactions 1. Ready Exchange Rate for Trade Transactions Exchange Quotations Basis for Merchant Rates Exchange Margin Fineness of Quotation Buying Rates

-- V

(1) TT Buying Rate Note: Example: Assuming Rupee /US dollars are quoted in the local interbank market as under: (iii) Bill buying Rate Solution: Selling rate: TT Selling Rate (iii) Bills Selling rate

Cross Rates Spot Cross Rates Forward Cross Rate (2) Ready Rates for Non-trading Transactions (a) Issue and encashment of foreign travellers cheques (b) Exchange Rates for Foreign Currency Notes (c) Exchange Rate for Clean Instruments

Forward Exchange Contracts Meaning and Features Problem Solution Fixed and Option Forward Contracts Uses of Forward Exchange Contracts Forward Rates Problems Inter Bank Deals: (1) Cover Deals (2) Swap Deals Need for Swap Deals

Arbitrage Operations: Kind of Arbitrage (1) (2) (3) (4) Two- Point Arbitrage Three- Point Arbitrage or Traingular Arbitrage Covered Interest Arbitrage Uncovered Interest Arbitrage

*********************************