The document provides an overview of various financial forces that impact international business, including foreign exchange rates, taxation, tariffs, and inflation. It discusses how changes in currency values and demand/supply of foreign exchange can affect payment balances for companies. Tariffs are described as taxes on imported goods that make foreign products more expensive for consumers. The document also outlines different exchange rate systems such as free floating, managed float, and fixed rates, and how government intervention works to influence currency values under these systems.

1. Financial Forces of International
Business
Submitted by:
Rai, Manju Kumari
Shrestha, Ruchi
Thapa Magar, Dipesh
Nepal, Rhishikesh
Submitted to:
Mr. Lhakpa Gelu Sherpa
Facilitator of IB

2. Contents of Financial Forces of International Business
1. Financial forces and its impact on international business arena
2. Foreign Exchange
3. Changes of demand and supply of foreign exchange
4. Free floating systems, managed float system and fixed system
5. Taxation and tariffs
6. How tariff is affecting international trade?
7. Inflation and deflation
8. The impact of inflation on international business
9. Balance of payment
10. What is indebtness?
11. Conclusion

3. 1. Financial forces and its impact on international business arena
Generally speaking, tariffs, inflation, and taxes influence international business. Currency exchanges
increase and decrease international business equally depending upon the condition of the economy.
Considering tariffs: if company XYZ exports motorcycles from its facility in Japan to the United States
and the US imposes tariffs on them as a direct result of congressional lobbying from domestic
manufacturers, then the company's payments resulting from sales would decrease. This makes profitable
business a difficult prospect because the consumer is generally not willing to pay a higher price for the
imported motorcycle. As a result, company XYZ must make up the difference by increasing its market
share or cut production costs in some manner.
Considering taxes: a firm selling a product has a cost to produce the product and sells it for a profit. Most
governments impose taxes on businesses which effectively decreases the payments realized by the firm
resulting from the sale and subsequent profit of its products. For international businesses, this is
especially important as foreign governments will likely levy taxes on sales in their country as will the
firm's domestic government when profits are brought home (double taxation in some cases).
Moreover, inflation will affect businesses because a currency's value now is usually not the same as its
future value. Suppose a firm invests in a foreign project and expects to realize cash flows of $100,000 per
month beginning in two years. This level of cash flows is sufficient for now, but inflation can erode the
value of the currency such that the value of $100,000 in two years may be only worth the same as $50,000
today (a dollar in two years will only buy what $0.50 will buy today). Firms must plan carefully relative
to inflationary forces when planning for fixed levels of cash flows resulting from projects in the future.
Furthermore, currency exchanges can either increase or decrease payment balances. When a firm's
domestic currency is strong, exchanging profits made in a foreign country will have the effect of
decreasing payment balances when they are brought home and vice versa. For example, a firm completes
a project in Germany and is paid 1,000,000 Euros for doing so. However, the firm's domestic currency
(the US dollar) is strong and is worth 2 Euros. As such, the exchange of the currency when the profits are
brought home will yield a $500,000 profit domestically. Contrastingly, if the dollar is weak and 1 Euro is
worth $2, the project will yield the company $2,000,000 in profit after the exchange of funds. Because
exchange rates change daily, profits realized from a lengthy foreign project can be eroded unexpectedly.
The company can leave the profits overseas until markets improve, but many countries (including the US)
are beginning to tax companies for doing so in an effort to have them bring money home sooner.
Finally, the impact of indebtness of a nation also impacts international business. The level of debt the
country gears from domestic market as well as external debt defines the environment for enhancing
international business. For example, if US do not start cutting its 14 trillion dollars of national debt it will
be submerged into inflation, recession, and huge deficit of balance of payments ultimately hindering the
environment for prosperity of business in the nation.

4. 2. Foreign Exchange
Foreign exchange, or Forex, is the conversion of one country's currency into that of another. In a free
economy, a country's currency is valued according to factors of supply and demand. In other words, a
currency's value can be pegged to another country's currency, such as the U.S. dollar, or even to a basket
of currencies. A country's currency value also may be fixed by the country's government. However, most
countries float their currencies freely against those of other countries, which keep them in constant
fluctuation.
The value of any particular currency is determined by market forces based on trade, investment, tourism,
and geo-political risk. Every time a tourist visits a country, for example, he or she must pay for goods and
services using the currency of the host country. Therefore, a tourist must exchange the currency of his or
her home country for the local currency. Currency exchange of this kind is one of the demand factors for
a particular currency. Another important factor of demand occurs when a foreign company seeks to do
business with a company in a specific country. Usually, the foreign company will have to pay the local
company in their local currency. At other times, it may be desirable for an investor from one country to
invest in another, and that investment would have to be made in the local currency as well. All of these
requirements produce a need for foreign exchange and are the reasons why foreign exchange markets are
huge.
Foreign exchange is handled globally between banks and all transactions fall under the auspice of the
Bank of International Settlements.
The value of a nation’s currency, under a floating exchange rate, is determined by the interaction of
supply and demand. We will work through some charts and an example to show how these forces work,
from a theoretical point of view.
3. Changes in Demand and Supply of foreign exchange
Factors affecting Demand and Supply of Exchange rate
• Imports and Exports
a rise in import will increase the supply of one’s currency consequence, is depreciation of the
currency. Vice versa for exports.
• Money supply of the currency
decrease in money supply of the currency will reduce its supply in the market and shift the supply
curve to left giving a rise to the price of the currency.
• Increase in foreign cash inflow
an increase in foreign inflow of cash will increase the demand for the currency appreciating the
price.

5. In figure, an increase in the US demand for the pound (rightward shift of the demand curve) causes a rise
in the exchange rate, an appreciation in the pound, and depreciation in the dollar. Conversely, a fall in
demand would shift the demand curve left and lead to a falling pound and rising dollar. On the supply
side, an increase in the supply of pounds to the US market (supply curve shifts right) is illustrated in
Figure, where a new intersection for supply and demand occurs at a lower exchange rate and an
appreciated dollar. A decrease in the supply of pounds shifts the curve leftward, causing the exchange rate
to rise and the dollar to depreciate. …………………………………………………………………….
When the forces between supply and demand change, the market moves in ways to clear itself through a
change in price.

6. In international finance markets, if many investors are selling a particular currency, they are making it
more readily available and increasing its supply. If there is not an equal amount of buyers, or demand, for
that currency, its price will go down in order to strike a new balance between supply and demand.
The direction in which the value of a currency is heading can cause cash to flow into or out of that
currency. A currency that is appreciating can cause money to flow into its country’s assets as investors
and Forex traders want to benefit from buying or taking “long” positions on the currency as the
currency’s price rises.
4. Exchange rate systems and international business.
a. Free-Floating Systems
In a free-floating exchange rate system, governments and central banks do not participate in the market of
foreign exchange. The relationship between governments and central banks on the one hand and currency
markets on the other is much the same as the typical relationship between these institutions and stock
markets. Governments may regulate stock markets to prevent fraud, but stock values themselves are left
to float in the market. The U.S. government, for example, does not intervene in the stock market to
influence stock prices.
The concept of a completely free-floating exchange rate system is a theoretical one. In practice, all
governments or central banks intervene in currency markets in an effort to influence exchange rates.
Some countries, such as the United States, intervene to only a small degree, so that the notion of a free-
floating exchange rate system comes close to what actually exists in the United States.
A free-floating system has the advantage of being self-regulating. There is no need for government
intervention if the exchange rate is left to the market. Market forces also restrain large swings in demand
or supply. Suppose, for example, that a dramatic shift in world preferences led to a sharply increased
demand for goods and services produced in Canada. This would increase the demand for Canadian
dollars, raise Canada’s exchange rate, and make Canadian goods and services more expensive for
foreigners to buy. Some of the impact of the swing in foreign demand would thus be absorbed in a rising
exchange rate. In effect, a free-floating exchange rate acts as a buffer to insulate an economy from the
impact of international events.
The primary difficulty with free-floating exchange rates lies in their unpredictability. Contracts between
buyers and sellers in different countries must not only reckon with possible changes in prices and other
factors during the lives of those contracts, they must also consider the possibility of exchange rate
changes. An agreement by a U.S. distributor to purchase a certain quantity of Canadian lumber each year,
for example, will be affected by the possibility that the exchange rate between the Canadian dollar and the
U.S. dollar will change while the contract is in effect. Fluctuating exchange rates make international
transactions riskier and thus increase the cost of doing business with other countries.

7. b. Managed Float Systems
Governments and central banks often seek to increase or decrease their exchange rates by buying or
selling their own currencies. Exchange rates are still free to float, but governments try to influence their
values. Government or central bank participation in a floating exchange rate system is called a managed
float.
Countries that have a floating exchange rate system intervene from time to time in the currency market in
an effort to raise or lower the price of their own currency. Typically, the purpose of such intervention is to
prevent sudden large swings in the value of a nation’s currency. Such intervention is likely to have only a
small impact, if any, on exchange rates. Roughly $1.5 trillion worth of currencies changes hands every
day in the world market; it is difficult for any one agency—even an agency the size of the U.S.
government or the Fed—to force significant changes in exchange rates.
Still, governments or central banks can sometimes influence their exchange rates. Suppose the price of a
country’s currency is rising very rapidly. The country’s government or central bank might seek to hold off
further increases in order to prevent a major reduction in net exports. An announcement that a further
increase in its exchange rate is unacceptable, followed by sales of that country’s currency by the central
bank in order to bring its exchange rate down, can sometimes convince other participants in the currency
market that the exchange rate will not raise further. That change in expectations could reduce demand for
and increase supply of the currency, thus achieving the goal of holding the exchange rate down.
c. Maintaining a Fixed Exchange Rate through
Intervention…………………………………………………

8. Initially, the equilibrium price of the British pound equals $4, the fixed rate between the pound and the
dollar. Now suppose an increased supply of British pounds lowers the equilibrium price of the pound to
$3. The Bank of England could purchase pounds by selling dollars in order to shift the demand curve for
pounds to D2. Alternatively, the Fed could shift the demand curve to D2 by buying pounds.
Fixed exchange rate systems offer the advantage of predictable currency values—when they are working.
But for fixed exchange rates to work, the countries participating in them must maintain domestic
economic conditions that will keep equilibrium currency values close to the fixed rates. Sovereign nations
must be willing to coordinate their monetary and fiscal policies. Achieving that kind of coordination
among independent countries can be a difficult task.
5. Taxation and tariffs
Another area of great financial importance is taxation. When determining where to pursue business
overseas, taxes can be very cost prohibitive, even when other financial, social and political forces are to
their advantage. Skillfully negotiating a lower tax burden can be the difference in having the ability to
offer a lower product price than ones competitor or not and should therefore be carefully considered.
Tariff and Tax in International Trade
A tariff or customs duty is a tax levied upon goods as they cross national boundaries, usually by the
government of the importing country. The words tariff, duty, and customs are generally used
interchangeably.
Tariffs may be levied either to raise revenue or to protect domestic industries, but a tariff designed
primarily to raise revenue may exercise a strong protective influence and a tariff levied primarily for
protection may yield revenue. Gottfried Haberler in his Theory of International Trade suggested that the
best objective distinction between revenue duties and protective duties (disregarding the motives of the
legislators) is to be found in their discriminatory effects as between domestic and foreign producers.
Tariffs may be further classified into three groups—transit duties, export duties, and import duties.
Transit Duties
This type of duty is levied on commodities that originate in one country, cross another, and are consigned
to a third. As the name implies, transit duties are levied by the country through which the goods pass.
Such duties are no longer important instruments of commercial policy, but, during the mercantilist period
(17th and 18th centuries) and even up to the middle of the 19th century in some countries, they played a
role in directing trade and controlling certain of its routes.
Export Duties
Export duties are no longer used to a great extent, except to tax certain mineral and agricultural products.
Several resource-rich countries depend upon export duties for much of their revenue. Export duties were
common in the past, however, and were significant elements of mercantilist trade policies. Their main
function was to safeguard domestic supplies rather than to raise revenue. At the beginning of the 20th
century only a few countries levied export duties: for example, Spain still levied them on coke and textile

9. waste; Bolivia and Malaya on tin; Italy on objects of art; and Romania on hides and forest products. The
neo-mercantilist revival in the 1920s and 1930s brought about a limited reappearance of export duties. In
the United States, export duties were prohibited by the Constitution, mainly because of pressure from the
South, which wanted no restriction on its freedom to export agricultural products.
Export duties may act as a form of protection to domestic industries. As examples, Norwegian and
Swedish duties on exports of forest products were levied chiefly to encourage milling, woodworking, and
paper manufacturing at home. Similarly, duties on the export from India of unbanned hides after World
War I were levied to stimulate the Indian tanning industry. In a number of cases, however, duties levied
on exports from colonies were designed to protect the industries of the mother country and not those of
the colony.
Import Duties
Import duties are the most important and most common types of custom duties. As noted above, they may
be levied either for revenue or protection or both, but tariffs are not a satisfactory means of raising
revenue, because they encourage uneconomic domestic production of the dutied item. Even if imports
constitute the bulk of the available revenue base, it is better to tax all consumption, rather than only
consumption of imports, in order to avoid uneconomical protection.
Import duties are no longer an important source of revenues in developed countries. In the United States,
for example, revenues from import duties in 1808 amounted to twice the total of government
expenditures, while in 1837 they were less than one-third of such expenditures. Until near the end of the
19th century the customs receipts of the U.S. government made up about half of all its receipts. This share
had fallen to about 6 percent of all receipts before the outbreak of World War II and it has since further
decreased.
A tariff may be either specific, ad valorem, or compound (i.e., a combination of both). A specific duty is a
levy of a given amount of money per unit of the import, such as $1.00 per yard or per pound. An ad
valorem duty, on the other hand, is calculated as a percentage of the value of the import. Ad valorem rates
furnish a constant degree of protection at all levels of price (if prices change at the same rate at home and
abroad), while the real burden of specific rates varies inversely with changes in the prices of the imports.
A specific duty, however, penalizes more severely the lower grades of an imported commodity. This
difficulty can be partly avoided by an elaborate and detailed classification of imports on the basis of the
stage of finishing, but such a procedure makes for extremely long and complicated tariff schedules.
Specific duties are easier to administer than ad valorem rates, for the latter often raise difficult
administrative issues with respect to the valuation of imported articles.
How tariff is affecting international trade?
It makes foreign products more expensive, which means that consumers have to pay more, which is bad.
It also means the inefficient firms in the protected industry get a free ride. That is very bad for the
economy. It means people will earn less in the country over all, and pay more for foreign goods. It means
less people will have jobs. It means inflation will be higher.
Tariffs are implied by the government because;
To protect fledgling domestic industries from foreign competition.
To protect aging and inefficient domestic industries from foreign competition.

10. To protect domestic producers from dumping by foreign companies or governments. Dumping occurs
when a foreign company charges a price in the domestic market which is "too low". In most instances
"too low" is generally understood to be a price which is lower in a foreign market than the price in the
domestic market. In other instances "too low" means a price which is below cost, so the producer is
losing money.
Who Benefits?.....................................................................................................................................
The benefits of tariffs are uneven. Because a tariff is a tax, the government will see increased revenue as
imports enter the domestic market. Domestic industries also benefit from a reduction in competition, since
import prices are artificially inflated. Unfortunately for consumers - both individual consumers and
businesses - higher import prices mean higher prices for goods. If the price of steel is inflated due to
tariffs, individual consumers pay more for products using steel, and businesses pay more for steel that
they use to make goods. In short, tariffs and trade barriers tend to be pro-producer and anti-consumer.
The effect of tariffs and trade barriers on businesses, consumers and the government shifts over time. In
the short run, higher prices for goods can reduce consumption by individual consumers and by businesses.
During this time period, businesses will profit and the government will see an increase in revenue
from duties. In the long term, businesses may see a decline in efficiency due to a lack of competition, and
may also see a reduction in profits due to the emergence of substitutes for their products. For the
government, the long-term effect of subsidies is an increase in the demand for public services, since
increased prices, especially in foodstuffs, leaves less disposable income. (For related reading, check out In
Praise Of Trade Deficits.)
How Do Tariffs Affect Prices?...................................................................................................
Tariffs increase the prices of imported goods. Because of this, domestic producers are not forced to
reduce their prices from increased competition, and domestic consumers are left paying higher prices as a
result. Tariffs also reduce efficiencies by allowing companies that would not exist in a more competitive
market to remain open……………………………………………………………………………………
Figure 1 illustrates the effects of world trade without the presence of a tariff. In the graph, DS means
domestic supply and DD means domestic demand. The price of goods at home is found at price P, while
the world price is found at P*. At a lower price, domestic consumers will consume Qw worth of goods,
but because the home country can only produce up to Qd, it must import Qw-Qd worth of goods.

11. Figure 1. Price without the influence of a tariff
When a tariff or other price-increasing policy is put in place, the effect is to increase prices and limit the
volume of imports. In Figure 2, price increases from the non-tariff P* to P'. Because price has increased,
more domestic companies are willing to produce the good, so Qd moves right. This also shifts Qw left.
The overall effect is a reduction in imports, increased domestic production and higher consumer prices
Figure 2. Price under the effects of a tariff

12. 6. Inflation and deflation
The spending power of one dollar is the goods that can be bought with that dollar. The spending power of
money can change overtime. If one dollar buys fewer goods this year than it did last year, then the value
of money has been caused by inflation. Inflation can be defined as an increase in the average price level
of goods and services.
If one dollar buys more goods this year than did last year, then the value of money has increased. This
must have been caused by deflation. Deflation can be defined as a fall in the average price level of goods
and services. The retail price index RPI is used to measure average price changes. An index number can
be used to record average changes in a large number of items.
Causes of inflation
1. Demand-pull. This means buyers want to buy more than sellers can actually produce; so sellers start to
put prices up.
2. Cost-push. This means business costs start to rise (eg oil prices rise, or wages start to rise) and sellers
need to put prices up to compensate.
3. Monetarist view. This means the government allows too much money to be created. If the supply of
money rises, then the price falls just as if the supply of potatoes rises, then the price falls. The price of
money here is how many goods and services it will buy. If the price of money falls, then it will buy fewer
goods and services i.e. prices of goods and services rise and the value of money falls. This is inflation.
The impact of inflation on international business
Cost increases can be passed on to consumers more easily if there is a general increase in prices.
The real value of debts owed by companies will fall. This means that, because the value of money is
falling, when a debt is repaid it is repaid with money of less value than the original loan. Thus, highly
geared companies see a fall in the real value of their liabilities.
Rising prices are also likely to affect assets held by firms, so the value of fixed assets, such as land and
building, could rise. This will increase the value of business and, when reflected on the balance sheet,
make the company more financially secure.
Since stocks are bought in advance and then sold later, there is an increased margin from the effect of
inflation.
Therefore, during inflation that are not excessive, business could decide to raise their own prices, borrow
more to invest and ensure that increased asset value appear on their balance sheet. However, high rates of
inflation say 10% and above can be damaging for the business
Staff will become much more concerned about the real value of their incomes. Higher wage demands are
likely and there could be an increase in industrial disputes.

13. Consumers are likely to become much more price sensitive and look for bargains rather than big names.
Rapid inflation will often lead to higher rates of interest. These higher rates could make it very difficult
for highly geared companies to find the cash to make interest payments, despite the fact that the real value
of the debts is declining.
Cash flow problems may occur for all businesses as they struggle to find more money to pay the higher
costs of materials and other costs.
If inflation is higher in one country than in other countries then business will lose its competiveness in
overseas market
Business that sells goods on credit will be reluctant to offer extended credit periods the repayments by
creditors will be with money that is losing value rapidly.
Consumers may stockpile some items or transfer thei disposable income t commodities that are more
likely to hold or increase value.
Business may be forced to cut back spending, cut profit margins to limit their price rises, reduce
borrowing to levels at which the interest payments are manageable hindering stimulation of investment,
and layoff workers.
INFLATION AND INTERNATIONAL TRADE
International trade and trade policy are difficult enough to understand when price levels remain relatively
constant. But when rapid or chronic inflation are added, most of us find that whatever grip we have on
economic principles begins to slip away. This is because general price inflation reflects changes in the
level and distribution of real income within countries and across national boundaries. Inflation also tends
to change currency exchange rates and international balance of payments accounts. This paper examines
briefly some of the major ways in which inflation can influence trade among nations. Inflation is a
sustained increase in the general price level of a national economy measured either at the retail or
wholesale level. The annual rate of change in this price level, commonly expressed in index numbers, is
the inflation rate.
Constant Inflation Rates
First imagine a curious world in which all trading nations display rapid but equal inflation rates. No
changes occur anywhere in relative prices-all conceivable price and cost ratios stay constant over time.
Since currency exchange rates are really price relatives, no exchange rates would change in response to
this inflation. Thus, no price induced changes in imports, exports, interest rates, capital flows, or balance
of payments would occur. Such a world would be uninteresting from our point of view unless this
constant international inflation rate was accompanied by unequal rates of change in real income. These
could emerge because of differential rates of growth in real output across international borders. Unequal
changes in real income could induce changes in commodity trade and foreign exchange through demand
shifts, but these would not be inflation phenomena as such. Now consider the more relevant case
involving differential inflation rates occurring from one trading nation to another.

14. Differential Inflation and Fixed Exchange Rates
For whatever underlying reasons, imagine that at least two major trading nations display substantially
different internal inflation rates affecting prices of both traded and non-traded goods. If the Rate of
Exchange of one nation's currency for that of the other is fixed; relative prices across the border would be
changing at a rate equal to the difference between the two inflation rates. For example, if the
U.S. inflation rate is 10 percent and the West German rate is 7 percent, then relative prices for U.S. goods
would be rising by 3 percent per year in terms of German currency. Similarly, relative prices for German
goods in U.S. currency would be falling at 3 percent per year. With fixed exchange rates, the exports of
the rapidly-inflating nation would tend to dwindle, and their imports would tend to rise.
In our example, this adjustment would dampen inflation in the United States and heighten it in Germany
if large balance of payments surpluses and deficits are not allowed to accumulate and if trade is
responsive to price change. This theoretically-tight, international linkage of economic activity and price
levels is a major advantage seen by supporters of the gold standard and other types of fixed exchange
rates. They favor the automatic external discipline on economic activity and inflation which such schemes
provide. With fixed currency exchange rates, inflation is clearly an export commodity. How easily and
rapidly inflation can move from nation to nation under fixed exchange rates depends upon the importance
of trade in total economic activity and the degree to which exports and imports respond to international
price differences. The more important trade is and the more responsive demand and supply are to price
changes, the more readily inflation will surge from one country to another.
Flexible exchange rate
The next step in this line of reasoning is to consider the trade impacts of flexible exchange rate
adjustments occurring in response to inflation. Fully-adjusting currency exchange markets would
completely neutralize the changes in relative prices implied by differential inflation rates. Hence, the
purchasing power parity doctrine with flexible exchange rates teaches that we should expect no
systematic international trade changes to flow from differential inflation rates themselves.
However, if a time lag exists in the rate at which exchange values adjust in response to differential
inflation, then the nation with the more rapid inflation will find its exports slipping and its imports rising.
Because the value of its currency will not be falling fast enough to maintain equal commodity price
relatives. So the net impact that price inflation itself has on international trade hinges upon where actual
currency exchange markets fit between the polar extremes of fixity and full flexibility.
The Current Situation For the last 10-15 years, the world's trading nations have been edging away from
fixed rates toward more flexible, market-determined exchange rates. Governments still intervene heavily
in money markets to influence currency values, and currencies of some nations are still welded together in
fixed-value blocks.
7.
CurrentAccount
The balance of the current account tells us if a country has a deficit or a surplus. If there is a deficit, does
that mean the economy is weak? Does a surplus automatically mean that the economy is strong? Not

15. necessarily. But to understand the significance of this part of the BOP, we should start by looking at the
components of the current account: goods, services, and income and current transfers.
1. Goods - These are movable and physical in nature, and in order for a transaction to be recorded
under "goods", a change of ownership from/to a resident (of the local country) to/from a non-
resident (in a foreign country) has to take place. Movable goods include general merchandise,
goods used for processing other goods, and non-monetary gold. An export is marked as a credit
(money coming in) and an import is noted as a debit (money going out).
2. Services - These transactions result from an intangible action such as transportation, business
services, tourism, royalties or licensing. If money is being paid for a service it is recorded like an
import (a debit), and if money is received it is recorded like an export (credit).
3. Income - Income is money going in (credit) or out (debit) of a country from salaries, portfolio
investments (in the form of dividends, for example), direct investments or any other type of
investment. Together, goods, services and income provide an economy with fuel to function. This
means that items under these categories are actual resources that are transferred to and from a
country for economic production.
4. Current Transfers - Current transfers are unilateral transfers with nothing received in return.
These include workers' remittances, donations, aids and grants, official assistance and pensions.
Due to their nature, current transfers are not considered real resources that affect economic
production.
Why a Current account is considered harmful to the economy
1. If a current account deficit is financed through borrowing it is said to be more unsustainable.
2. Borrowing is unsustainable in the long term and countries will be burdened with high interest payments.
E.g. Russia was unable to pay its foreign debt back in 1998. Other developing countries have experience
similar repayment problems Brazil, African c (3rd World debt)
3. Foreigners have an increasing claim on UK assets, which they could desire to be returned at any time.
E.g. a severe financial crisis in Japan may cause them to repatriate their investments
4. Export sector may be better at creating jobs
5. A Balance of Payments deficit may cause a loss of confidence
However a current account deficit is not necessarily harmful
1. Current Account deficit could occur during a period of inward investment (surplus on financial account)
E.g. US ran a current account deficit for a long time as it borrowed to invest in its economy. This enabled
higher growth and so it was able to pay its debts back and countries had confidence in lending the US
money
2. Japanese investment has been good for UK economy not only did the economy benefit from increased
investment but the Japanese firms also helped bring new working practices in which increased labor
productivity.
3. With a floating exchange rate a large current account deficit should cause a devaluation which will help
reduce the level of the deficit

16. It depend on the size of the budget deficit as a % of GDP, for example the US trade deficit has nearly
reached 5% of GDP (02/03) at this level it is concerning economists
The Capital and Financial Accounts ....................................................................................................
Along with transactions pertaining to non-financial and non-produced assets, the capital account relates to
dealings including debt forgiveness, the transfer of goods and financial assets by migrants leaving or
entering a country, the transfer of ownership on fixed assets, the transfer of funds received to the sale or
acquisition of fixed assets, gift and inheritance taxes, death levies, patents, copyrights, royalties and
uninsured damage to fixed assets.
Detailed in the financial account are government-owned assets ((i.e., special drawing rights at
the International Monetary Fund (IMF) or foreign reserves)), private sector assets held in other countries,
local assets held by foreigners (government and private), foreign direct investment, global monetary flows
related to investment in business, real estate, bonds and stocks.
Capital that is transferred out of a country for the purpose of investing is recorded as a debit in either of
these two accounts. This is because money is leaving the economy. But because it is an investment, there
is an implied return. This return - whether a capital gain from portfolio investment (a debit under the
financial account) or a return made from direct investment (a debit under the capital account) - is recorded
as a credit in the current account (this is where income investment is recorded in the BOP). The opposite
is true when a country receives capital: paying a return on a said investment would be noted as a debit in
the current account.
8. What is indebtness?
Indebtness is the state of a nation being in debt. The national debt of nation can be raised from domestic
market as well as external debt. at many instances the country issues various securities like treasury stock
like that of Nepal, which is at 9%, bonds etc. this is sold to domestic people and entities which is known
as domestic borrowing. Likewise, this security is also sold to other nations and international entities for
raising finance for the country. Many countries also acquire direct loans from other nations like Nepal
getting loan from US. Moreover the nation is indebt from loans acquired from big international
institutions like World Bank or IMF- international monetary fund.
Excesses in debt accumulation have been blamed for exacerbating economic problems. For example,
prior to the beginning of the Great Depression debt/GDP ratio was very high. Economic agents were
heavily indebted. This excess of debt, equivalent to excessive expectations on future returns, accompanied
asset bubbles on the stock markets. When expectations corrected, deflation and a credit
crunch followed. Deflation effectively made debt more expensive and, as Fisher explained, this reinforced
deflation again, because, in order to reduce their debt level, economic agents reduced
their consumption and investment. The reduction in demand reduced business activity and caused further
unemployment. In a more direct sense, more bankruptcies also occurred due both to increased debt cost
caused by deflation and the reduced demand.

17. External Debts:
External debt (or foreign debt) is that part of the total debt in a country that is owed to creditors outside
the country. The debtors can be the government, corporations or private households. The debt includes
money owed to private commercial banks, other governments, or international financial institutions such
as the International Monetary Fund (IMF) and World Bank. The debts to the developing countries have
been recognized as one of the major obstacles of sustainable human and economic development.
In some of the small countries debts have been properly utilized like in Bhutan and Lesotho debts are
used in mega hydro electricity generation projects and therefore the per capita debt are very high. But for
many developing countries debt have become obstacles for reason like:
1. Mismanagement
2. Mis-utilization
3. Rampant corruption and embezzlement by the elite
4. Customers siphoning-off by project contractor, international agencies and institutions in
the form of overhead, interests, over valuation and other costs.
The following are the internal and external reasons for the indebtedness of poor developing and least
developed countries:
1. Mounting world inflationary pressure due to increase in the price of the fuels,
commodities and food stuffs.
2. Rising values of easily convertible currencies of developed countries due to their steady
economic growth.
3. Low domestic production or income growth rate in developing and poor nations.
4. Chronic and inherited political and socioeconomic constraints and shortcomings.

18. Conclusion
To sum up this report's analysis can be shown in a cycle:
national debt
start of rapid
money supply recession
and inflation
worsening of
losing business
BOP and
competitiveness
unemployment
In the above figure all the financial forces implication on the business and economy is shown. First the
cycle starts from the national debt, the country acquires debt when it is unable to support its expenditures
and revenue cannot sustain its expenses. If a country rises too much of national debt at such instances it
becomes unable to support its obligation, even paying the interest on loan starts becoming troublesome. in
such crisis the nation applies the short term measure and simply print more money and supply to banks so
as to honor the debt.
Moreover, if there is something of more amounts its value goes down. This is inflation. More money
supply simply reduces the value of the currency and makes goods expensive. the nations market will get
damped because now the domestic industry experiences the rise in factor cost because of inflation and
imports from countries having competitive advantage in terms of cost will take up the domestic market
share like goods from China, India, Taiwan etc. the country's goods also loses its competitiveness
internationally as there is rise of the price of its goods.
At such instance of losing of competitiveness, the industry that wants to thrive relocates abroad where
they can find cheap factor of production. The country continues to import to satisfy its domestic
consumption. The domestic industries are losing their competitiveness and have started to close down.
The export is in decline. Foreign companies do not want to operate in the nation because of inflation and
prospect of recession and instability. Thus, this gives rise to inflation, poor balance of payment,
unemployment in the nation because of shutting of businesses consequensing recession.
Furthermore, when the country experiences recession it is in much more pressure to increase its
government expenditure. More amount of money is to be spent in welfare payments and the nation will be
in huge pressure to pay its debt. This is the instance experienced by Greece. Now the nation will be
compelled to acquire more loans from other nations and entities from which it has not loaned before. This
will in turn increase the national debt. Thus, if the governments do not intervene and check the situation
then this effect will be trickling and the cycle continues.