Current Economic Scenario and Risks in Exports

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Lecture to MBA students attending "Exports Management" workshop

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Current Economic Scenario and Risks in Exports

  1. 1. EXPORT MANAGEMENT Current Economic Scenario and Risks in Exports
  2. 2. What Is International Trade? <ul><ul><li>If you walk into a supermarket and are able to buy South American bananas, Brazilian coffee and a bar of Swiss chocolate, you are experiencing the effects of international trade. </li></ul></ul><ul><ul><li>International trade is the exchange of goods and services between countries. This type of trade gives rise to a world economy, in which prices, or supply and demand, affect and are affected by global events. </li></ul></ul>
  3. 3. What Is International Trade? <ul><ul><li>Political change in Asia, for example, could result in an increase in the cost of labor, thereby increasing the manufacturing costs for an American sneaker company based in Malaysia, which would then result in an increase in the price that you have to pay to buy the tennis shoes at your local mall. A decrease in the cost of labor, on the other hand, would result in you having to pay less for your new shoes. </li></ul></ul>
  4. 4. Global Trends 2025 The National intelligence council's 2025 Project <ul><li>  </li></ul><ul><li>  </li></ul><ul><ul><ul><li>Unprecedented economic growth, coupled with 1.5 billion more people, will put pressure on resources—particularly energy, food, and water—raising the specter of scarcities emerging as demand outstrips supply. </li></ul></ul></ul><ul><ul><ul><li>The potential for conflict will increase owing partly to political turbulence in parts of the greater Middle East. </li></ul></ul></ul>
  5. 5. Global Trends 2025 The National intelligence council's 2025 Project <ul><li>  </li></ul><ul><ul><ul><li>The whole international system—as constructed following WWII—will be revolutionized. Not only will new players—Brazil, Russia, India and China— have a seat at the international high table, they will bring new stakes and rules of the game. </li></ul></ul></ul><ul><ul><ul><li>The unprecedented transfer of wealth roughly from West to East now under way will continue for the foreseeable future.   </li></ul></ul></ul>
  6. 6. A new economic geography For the past 50 years economic power has been firmly rooted within the United States, Europe and Japan. As recently as 1990, the only emerging markets in the world’s top 10 economies were Russia and Brazil, in seventh and eighth place respectively. Today that list would include China as the world’s fourth-largest economy and by 2015 it is likely to feature India and South Korea. The world is moving from an era of geographically concentrated economic power to one characterized by multiple centers of economic and business activity.
  7. 7. India's position <ul><ul><li>Today, India is the fourth largest economy in the world in purchasing power parity (PPP) terms and the second-fastest in terms of growth. It is a tribute to the resilience of the Indian economy that even in the midst of the deep recession that the world is going through today, India remains a growing economy. Our growth, no doubt, has moderated but this moderation is modest compared to the convulsions almost everywhere else in the world. </li></ul></ul>
  8. 8. Why is this economic geography changing? <ul><ul><li>  </li></ul></ul><ul><ul><li>  </li></ul></ul><ul><ul><li>The rise of the new multi-polar world is not happening by accident or simply as a consequence of broader economic convergence between nations. It is being driven by three powerful, mutually reinforcing trends </li></ul></ul>
  9. 9. Why is this economic geography changing? <ul><li>  </li></ul><ul><ul><li>The increasing reach of information and communications technologies </li></ul></ul><ul><ul><li>  </li></ul></ul><ul><ul><li>  </li></ul></ul><ul><ul><li>Policies to increase economic openness </li></ul></ul><ul><ul><li>  </li></ul></ul><ul><ul><li>  </li></ul></ul><ul><ul><li>Increasing size and reach of the multinational enterprise </li></ul></ul>
  10. 10. Changing world order
  11. 11. What is wrong with US? <ul><ul><li>U.S. citizens comprise less than 5% of world population, but account for more than 25% of global GDP </li></ul></ul><ul><ul><li>The World Won't Buy Unlimited U.S. Debt: Peter Schiff's Editorial in The Wall Street Journal January 23, 2009 </li></ul></ul><ul><ul><li>&quot;Trillion dollar deficits for years to come.&quot; </li></ul></ul><ul><ul><li>Paltry 2%-3% yield  bonds </li></ul></ul>
  12. 12. What is wrong with US? <ul><ul><li>America's GDP is composed of more than 70% consumer spending. </li></ul></ul><ul><ul><li>For many years, much of that spending has been a function of voracious consumer borrowing through home equity extractions averaging more than $850 billion annually in 2005 and 2006 </li></ul></ul><ul><ul><li>Now that credit is scarce, it is inevitable that GDP will fall </li></ul></ul><ul><ul><li>Paul Krugman estimated that a 6.8% contraction in GDP will result in $2.1 trillion in &quot;lost output,&quot; </li></ul></ul>
  13. 21. Risk Management in Exports <ul><li>Risk is a fact of life. What we expect does not happen. Sometimes, something totally unexpected happens. The same way, business too is full of risks. In the course of international trade, where a number of agencies are involved in the process of imports and exports, any number of things can go not according to our expectations but differently. </li></ul><ul><li>Imports and Exports activity entails more risks than the inland sales or purchase transactions and in case of any unexpected event happening, the costs involved could be quite high. For example, litigation abroad could be very costly. Even insurance against several risks involved in the import export transactions may not be available. </li></ul><ul><li>Risk Management is also lot more than buying insurance.  </li></ul>
  14. 22. Risk Management <ul><li>ISSUE </li></ul><ul><li>Political Situation </li></ul><ul><li>Tax/Legal </li></ul><ul><li>•  Permanent Establishment </li></ul><ul><li>•  Personal Taxes </li></ul><ul><li>•  Jurisdiction/Venue </li></ul><ul><li>•  VAT/Local Taxes </li></ul><ul><li>Credit Quality </li></ul><ul><li>Currency Risk/Bank Regulations </li></ul><ul><li>RISK CONTROL </li></ul><ul><li>Political Risk Insurance </li></ul><ul><li>Contractual Provisions </li></ul><ul><li>Treaty Language </li></ul><ul><li>Personal Filings </li></ul><ul><li>Credit/Political Risk Insurance </li></ul><ul><li>Standby L/C’s </li></ul><ul><li>Payment Schedule </li></ul><ul><li>Central Bank Regulations </li></ul><ul><li>Convertibility/Volatility </li></ul><ul><li>Expense/Revenue Matching </li></ul>
  15. 23. Political Risk, Transfer Risk & Commercial Risk <ul><li>First, there is political risk associated with the government in the buyer’s country. This covers possibilities such as the imposition of foreign exchange controls and expropriation. Second, there is transfer risk involving the economy of the buyer’s country. Transfer risk is the risk that, due to the fact his country has a negative balance of payments, no foreign exchange (U.S. dollars or other “hard” currency) may be available to the buyer when he is ready to pay for the goods he has purchased.   </li></ul>
  16. 24. Commercial Risk <ul><li>The final uncertainty involves commercial risk, the normal risk, also found in domestic sales, of whether the buyer can and will pay the seller when payment is due. But in an international sale, because the buyer is in another country, the seller generally not only has less reliable information regarding his financial condition and integrity but also typically has fewer avenues of redress should the buyer fail to pay or otherwise violate the agreed-upon terms of sale. The existence of these political, transfer, and commercial risks explains why only about half of international sales are made on an open account basis. </li></ul>
  17. 25. Transport <ul><li>It is, of course, an understatement to say that doing business with someone in another country is more complicated than just finding ways to transport goods over long distances. </li></ul><ul><li>One of the most obvious differences from doing business domestically is the fact that goods must clear customs when crossing international boundaries. This requires documentation of merchandise type and value. </li></ul><ul><li>Another difference is the fact that steamship companies traditionally issue bills of lading as receipts for the goods they transport and require that the party who comes to the port of destination to claim goods surrender an original copy of the bill of lading to prove he has proper title to the goods -more documentation.  </li></ul>
  18. 26. Documentation <ul><li>Indeed, international trade revolves around documentation - documentation that the exporter of goods originates or obtains and that the importer of goods needs in order to gain possession of those goods. Because of this, buying and selling goods that cross national borders revolves around exchanging documents for payment. </li></ul>
  19. 27. An Example of Hedging Using Forward Agreement <ul><li>Assume that a Malaysian construction company, Bumiways just won a contract to build a stretch of road in India. The contract is signed for 10,000,000 Rupees and would be paid for after the completion of the work. This amount is consistent with Bumiways minimum revenue of RM1,000,000 at the exchange rate of RM 0.10 per Rupee.  </li></ul><ul><li>However, since the exchange rate could fluctuate and end with a possible depreciation   of Rupees, Bumiways enters into a forward agreement with  State  Bank of India to fix the exchange rate at RM0.10 per Rupee. </li></ul><ul><li>The forward contract is a legal agreement, and therefore constitutes an obligation on both sides.   </li></ul>
  20. 28. Forward contract <ul><li>State Bank may have to find a counter party for this transaction – either a party who wants to hedge against the appreciation of 10,000,000 Rupees expiring at the same time or a party that wishes to speculate on an upward trend in Rupees. If the bank itself plays the counter party, then the risk would be borne by the bank itself. The existence of speculators may be necessary to play the counter party position. By entering into a forward contract Bumiways is guaranteed of an exchange rate of RM 0.10 per Rupee in the future irrespective of what happens to the spot Rupee exchange rate.  </li></ul>
  21. 29. Forward contract <ul><li>If Rupee were to actually depreciate, Bumiways would be protected. However, if it were to appreciate, then Bumiways would have to forego this favourable movement and hence bear some implied losses. Even though this favourable movement is still a potential loss, Bumiways proceeds with the hedging since it knows an exchange rate of RM 0.10 per Rupee is consistent with a profitable venture. </li></ul>
  22. 30. Risk: Will we ever learn? <ul><li>For years institutions have taken a scientific approach to operational risk as science but have we lost sight of the real issues? Liquidity risk, counterparty risk and exposure management by many institutions has been shown to be deficient by the events of the last two years. Have we lost sight of the basics? If so how do we get back to sound operational risk management with better exposure management? What do we need to focus on first? </li></ul>
  23. 31. Risk: Will we ever learn? <ul><li>What are the priorities that should be considered when tackling the various aspects of risk in the future? Regulatory requirements cut right across the business - from financial reporting to the screening for sanctions lists. How will regulatory requirements develop going forward? How can infrastructures, such as CCPs, play a useful role in containing risk and allowing firms to realistically outsource some risk? What is the level of investment needed in risk management to operate effectively in the future? </li></ul>
  24. 32. 5 day Test Match vs. 20-20 <ul><li>http://www.tradecard.com/about/faq.html </li></ul><ul><li>http://www.swift.com/ </li></ul><ul><li>http://www.bolero.net/ </li></ul><ul><li>http://www.iccwbo.org/ </li></ul><ul><li>http://www.iccindiaonline.org/ </li></ul><ul><li>“ The world economy relies upon the financing of trade to keep the wheels of commerce turning, and now more than ever the financial services industry is in need of innovative solutions to close the liquidity gap in trade finance and ultimately stimulate growth.”     </li></ul>

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