International Flow of Funds (MTM).ppt

Dr. Md Tapan Mahmud
FBS, BUP
CHAPTER 02
INTERNATIONAL FLOW OF FUNDS

CHAPTER LEARNING OBJECTIVES
• To explain the key components of the balance of payments (BOP)
• To explain the growth in international trade activity over time
• To explain how the international flow of funds is influenced by
economic factors and other factors
• To explain how the international capital flows are influenced by
country characteristics
• To Introduce the agencies that facilitate the international flow of
funds

BACKGROUND
• Many MNCs are heavily engaged in international business
• Exporting
• Importing
• Direct foreign investment (DFI)
• The transactions arising from international business cause money flows from
one country to another
• The balance of payments (BOP) is a measure of international money flows

BACKGROUND
• Financial managers of MNCs monitor the BOP so that they can determine how
the flow of international transactions is changing over time
• The BOP can indicate the volume of transactions between specific countries; it
can also signal potential shifts in specific exchange rates
• Therefore, it can have a major influence on the long-term planning and
management by MNCs

2-1 BALANCE OF PAYMENT (BOP)
• The balance of payments (BOP) is a measurement of all transactions between
domestic and foreign residents over a specified period of time – quarter or a
year
• Includes transactions by businesses, individuals, and the government
• BOP is composed of three items:
• Current Account
• Financial Account
• Capital Account

2-1 BALANCE OF PAYMENT
A. CURRENT ACCOUNT
• The current account measures the flow of funds between one country and all
other countries due to purchases of goods and services or to income
generated by assets.
• Components of Current Account:
1. Merchandise (goods) and services
2. Primary income
3. Secondary income
• A current account deficit suggests a greater outflow of funds from the
specified country for its current transactions.

A. CURRENT ACCOUNT – PAYMENTS FOR GOODS & SERVICES
• Merchandise/Service exports and imports represent products, such as
smartphones, clothing, tourism that are transported between countries.
• The difference between total exports and imports is referred to as the balance
of trade.
• A deficit in the BD balance of trade means that the value of merchandise and
services exported by the BD is less than the value of merchandise and services
that it imports.

A. CURRENT ACCOUNT – PRIMARY INCOME PAYMENTS
• Primary income (factor income):
• income earned by MNCs on their DFI (investment in fixed assets for business
operations)
• income earned by investors on portfolio investment (investments in foreign securities)
• Primary income received by the Bangladesh reflects an inflow of funds into the
Bangladesh. Primary income paid by the Bangladesh to foreign companies or
investors reflects an outflow of funds from the Bangladesh.
• Net primary income represents the difference between the primary income
receipts and the primary income payments.

A. CURRENT ACCOUNT – SECONDARY INCOME
• The third main component of the current account is secondary income (transfer
payments) – aid, grants, and gifts from one country to another.
• Net secondary income represents the difference between the secondary income
receipts and the secondary income payments.

A. CURRENT ACCOUNT – TRANSACTION EXAMPLES

B. FINANCIAL ACCOUNT
• The financial account measures the flow of funds between countries that are due
to
1. Direct foreign investment (DFI)
2. Portfolio investment
3. Other capital investment

B. FINANCIAL ACCOUNT – DIRECT FOREIGN INVESTMENT (DFI)
• The financial account keeps track of a country’s payments for new DFI over a
given period – quarter or year.
• Acquisition of a foreign company
• To construct a new manufacturing plant in a foreign country
• To expand an existing plant in a foreign country
• Positive number: Payments representing DFI in the United States – acquisition of
a U.S. firm by a non-U.S. firm; here, funds are flowing into the United States
• Negative number: payments representing a U.S.-based MNC’s DFI in another
country; here, funds are being sent from US…

B. FINANCIAL ACCOUNT – PORTFOLIO INVESTMENT
• A country’s payments for a new portfolio investment over a specific period
• Financial asset (stock or bond) investment
• A purchase of Heineken International (Netherlands) stock by a U.S. investor is
classified as portfolio investment because it represents a purchase of foreign
financial assets without changing control of the company
• This transaction is recorded as a negative number for the U.S. financial account (a
debit), as it reflects a payment from the United States to another country.

B. FINANCIAL ACCOUNT – OTHER CAPITAL INVESTMENT
• It represents transactions involving short-term financial assets, such as money
market securities between countries.
• Treasury Bill (T-bills)
• Certificate of Deposits (CDs)
• Commercial Paper
• Repurchase Agreements (repos)
• Comparison:
• DFI means the fresh establishment or expansion of firms’ foreign operations
• Portfolio investment and other capital investment measure the net flow of funds due
to financial asset transactions between individual or institutional investors

C. CAPITAL ACCOUNT
• The capital account measures the flow of funds between one country and all
other countries due to financial assets transferred across country borders by
people who move to a different country, or due to sales of patents and
trademarks
• The sale of patent rights by a U.S. firm to a Canadian firm is recorded as a
positive amount (a credit) to the U.S. capital account because funds are being
received by the United States as a result of the transaction.
• Conversely, a U.S. firm’s purchase of patent rights from a Canadian firm is
recorded as a negative amount (a debit) to the U.S. capital account because
funds are being sent from the United States to another country.

C. CAPITAL ACCOUNT
• In general, the financial account items represent very large cash flows between
countries.
• Whereas the capital account items are relatively minor (in terms of dollar
amounts) when compared with the financial account items.
• Hence, the financial account is given much more attention than the capital
account when attempting to understand how a country’s investment behavior
has affected its flow of funds with other countries during a particular period.

RELATIONSHIPS BETWEEN THE ACCOUNTS
• If a country has a negative current account balance, then it should have a
positive financial and capital account balance (and vice versa).
• This implies that if it sends more money out of the country than it receives from
other countries due to international trade and income payments, it receives more
money from other countries than it spends on foreign investments.

BANGLADESHI BOP CONTEXT
• https://www.bb.org.bd/en/index.php/econdata/bopindex

2-2 GROWTH IN INTERNATIONAL TRADE
BACKGROUND
• Developed countries (USA) has greatly benefited from international trade:
• Created some US-jobs, (especially, domestic technology firms);
• It has shifted production to countries with more efficient manufacturing capability
• It ensures more global competition; prices become low
• Citizens have more product choices
• Conversely, in certain industries USA employees have lost jobs since production
is shifted
• Therefore, international trade has become a controversial issue, lately.

A. EVENTS THAT INCREASED TRADE VOLUME
Fall of
Berlin Wall
in 1989
The EU in
2004
GATT in
1993
NAFTA in
1993
Single
European
Act 1987
(1992)
Inception of
the Euro

A. EVENTS – FALL OF BERLIN WALL, 1989
• Wall separating East and West Germany was torn down.
• Encouraged the development of free enterprise in the Eastern European countries
• Promoted the privatization of business
• MNCs began to export to the Eastern part of Europe
• Some capitalized on the cheap labor of the Eastern European countries

A. EVENTS – SINGLE EUROPEAN ACT OF1987,1992
• In the late 1980s, industrialized European countries made a pact to make
regulations more uniform to remove taxes among the pact-members.
• Single European Act was formalized in 1987
• It was followed by a series of negotiation to achieve uniform policies by 1992
• This allows the European countries to have greater access to supplies from other
European countries

A. EVENTS – NAFTA,1993
• North American Free Trade Agreement (NAFTA)
• Trade barriers between the USA and Mexico was eliminated
• Allowed USA firms to penetrate product and labor markets that were inaccessible
• Allowed Mexican firms to export to USA and USA firms faced fresh competition
• USA firms lost market share to their Mexican competitors who produced cheaply
• Therefore, USA government is now seeking to renegotiate some aspects of

A. EVENTS – GATT,1993
• General Agreement on Tariffs and Trade (GATT)
• Elimination of trade restriction on specified imported goods for a 10-year period
across 117 countries

A. EVENTS – THE EUROPEAN UNION (EU), 2004
• As of 2018, EU consisted of 28 European countries that subscribe to the free
movement of products, service and capital. Before 2004, EU had only Western
European countries; in 2004, EU expanded into Eastern Europe
• To take the cheap labor advantage of the Eastern European countries many have
established manufacturing plants there
• EU is successful in providing free movement of products/services and
unsuccessful in developing a standard immigration policy
• In 2016, UK people were concerned about immigration and regulatory regime
and voted for BREXIT – confirmed in 31-12-2020
• https://www.youtube.com/watch?v=30pn4CaS2_M

A. EVENTS – EURO, 2002
• 11 EU member countries adopted the euro as a new currency replacing their
local currency; 8 other countries joined this eurozone, gradually
• All countries adopting euro are subject to the same monetary policy
• Eurozone MNCs are not required to convert their reciprocal currencies to trade
• It helps to avoid the exchange rate risk

B. IMPACT OF OUTSOURCING ON TRADE
• Outsourcing – subcontracting to a third party to provide services/supplies
• Allows MNCs to operate at a lower cost, enabling theme to compete globally
• It create jobs in the subcontracted countries; however, it also reduces
employment in the contracting country
• MNCs argue – without outsourcing they would have shut down some facilities
• There are many opinions about outsourcing; nonetheless, there is no simple
solution

B. IMPACT OF OUTSOURCING ON TRADE

B. OUTSOURCING – RELATED MANAGERIAL DECISIONS
• Same product with same quality can be produced in a foreign country at 1/5th of
the cost – Shareholders pressurize to go for outsourcing:
• Cost saving leads to more profit
• Profit leads to shareholders’ wealth maximization
• What the board should do?
• Board might consider the potential cost saving from outsourcing
• Board also need to account for the bad publicity or bad morale of the home
employees
• The amount of cost saving could be a determining factor in this case

C. TRADE VOLUME AMONG COUNTRIES
• Reliance on international trade (export/import) differs among countries
• USA & Japan are less dependent on international trade – 10-20% of the annual
GDP
• Canada, France, Germany and other European countries rely heavily on trade
• Canada’s figure is more than 50% of GDP
• European countries – 30-40% of GDP

2-3 FACTORS AFFECTING INTERNATIONAL TRADE FLOWS
The following factors are the most influential in impacting international trade:
A. Cost of Labor
B. Inflation
C. National Income
D. Credit conditions
E. Government policies and
F. Exchange rates

A. COST OF LABOR
• The cost of labor varies substantially among countries.
• Many of China’s workers earn less than $300 per month
• China’s firms commonly make products that require manual labor—at a much lower
cost than most countries in Europe and North America.
• Wage of the Eastern European countries tend to be much lower than the Western
part
• Firms in countries where labor costs are low typically have an advantage when
competing globally, especially in labor-intensive industries.

B. INFLATION
• If a country’s inflation rate increases compared to its trading countries:
• Export decreases – if foreign customers shift to a cheaper alternative
• Import increases – if locals shift to a cheaper alternative
• Consequently, a country with a high inflation rate is likely to experience a
decrease in its current account

C. NATIONAL INCOME AND D. CREDIT CONDITION
• If a country’s national income rises at a higher rate compared to its trading
countries:
• Consumption of goods rises
• It causes a surge in the demand for foreign goods
• Therefore, current account decreases
• Credit conditions tend to tighten when economic conditions weaken:
• Corporations are less able to repay debt.
• Banks are less willing to provide financing to MNCs
• These reduce corporate spending and further weaken the economy.
• An unfavorable credit environment may reduce international trade

E. GOVERNMENT POLICIES
• There are several types of policies that are often used to improve the balance of
trade deficit and job creation within a country.
1. Restrictions on Imports (Tariffs, Quota, Embargo etc.)
2. Subsidies for Exporters (Dumping and Anti-Dumping)
3. Restrictions on Piracy
4. Environmental restrictions
5. Labor Laws and Business laws
6. Tax breaks
7. Country Trade Requirements
8. Government ownership/subsidies
9. Policies to Punish Country Governments

• 1. Restriction on Imports:
• Tariff – imposes a tax on imported goods to protect the domestic industries
• Quota – enforcing a maximum limit on imports in economic condition
• Embargo – barring the import of items
(https://www.youtube.com/watch?v=LMTW9NdrOi8 )
• After BREXIT, the UK is subject to a 10% tariff while exporting to EU countries and UK
may do the same – it has a dual impact on employment
• 2. Subsidies for Exporters:
• Government subsidies on selected goods push the price down
• Make the subsidized firms more competitive in the global markets
• Dumping – selling subsidized products
(https://www.youtube.com/watch?v=6qFkn_4duj0 )

• 3. Restrictions on Piracy:
• Piracy discourages MNCs to import into certain markets
• The USA has a large trade deficit with China because of piracy

• 4. Environmental Restrictions:
• Environmental restrictions/requirements push the production costs up
• Non-restricted firms have upper hands over the restricted firms
• Releasing such restrictions enable local firms to compete globally; however, it creates a
conflict with the environmental activists
• 5. Labor Laws and Business Laws:
• Finland, Japan, Germany have strict labor laws covering the rights of employees
• Kazakhstan, Egypt, Bangladesh has flexible labor laws
• Countries with strict labor laws incur more production cost
• In subcontinent countries MNCs send bribes to get contracts or to bend laws

• 6. Tax Breaks:
• MNCs may receive tax breaks that operate in certain industries or invest in certain R&D
• Renewable energy industries, investment in green technology
• 7. Country Trade Requirements:
• MNCs are sometimes required to collect various forms, licenses, permits
• Governments are sometimes purposefully inefficient to process these requirements
• They make this bureaucratic barrier to retaliate against a certain country or to protect
local jobs

• 8. Government Ownership or Subsidies:
• Government owns major exporting firms and provides them subsidies/bail out
opportunities
• China – subsidies to the auto manufacturer and auto parts industry
• USA – bailing out GM in 2009 by purchasing a large number of their shares
• 9. Policies to Punish Country Governments:
• Some govt. impose trade restrictions on countries with low regard for human rights
and environmental laws
• Again, some govt. permits free trade without restrictions

E. GOVERNMENT POLICIES – SUMMARY
• The field of international trade is not level for all the countries!
• Most govt. implement trade restrictions to secure local jobs and export
advantage
• Any govt. can find an argument for restricting imports
• Negatively affected countries may retaliate against specific countries!
• MNCs can’t control trade policies; however, they can analyze and strategize:
• Potential tariff barrier can be trumped by DFI decision

F. EXCHANGE RATES
• Exchange rates facilitate international transactions
• The values of most currencies fluctuate over time because of the market and
government forces.
• As the currency strengthens, goods exported by that country will
become more expensive to the importing countries and thus the demand for
such goods will decrease.
• If a country’s currency begins to rise in value against other currencies, then its
current account balance should decrease, other things being equal.

F. EXCHANGE RATES

F. EXCHANGE RATES
• How Exchange Rates May Correct a Balance-of-Trade Deficit:?
• A floating exchange rate could correct any international trade imbalance between two
countries
• A balance-of-trade deficit suggests that the country is spending more funds on foreign
products than it is receiving from exports to foreign countries
• This exchange of its currency (to buy foreign goods) in greater volume than the foreign
demand for its currency could place downward pressure on the value of that currency.
• Once the country’s home currency’s value declines in response to these forces, the
result should be more foreign demand for its products.

F. EXCHANGE RATES – J CURVE EFFECT
• The J CURVE Effect: In economics, it is often used to observe the effects of a
weaker currency on trade balances. The pattern is as follows:
• Immediately after a nation's currency is devalued, imports get more expensive and
exports get cheaper, creating a worsening trade deficit (or at least a smaller trade
surplus).
• Shortly thereafter, the sales volume of the nation's exports begins to rise steadily,
thanks to their relatively cheap prices.
• At the same time, consumers at home begin to buy more locally-produced goods
because they are relatively affordable compared to imports.
• Over time, the trade balance between the nation and its partners bounces back and

F. EXCHANGE RATES – J CURVE EFFECT
U.S.
Trade
Balance
0 Time
J Curve

F. EXCHANGE RATES
• Why Exchange Rates (weak home currency) May Not Correct a Balance-of-Trade
Deficit?
1. Balance of trade deficit may be offset by positive net financial flow – currency will not
be weak
2. Many foreign competitors might lower their prices to compete.
3. home currency might not be weakened against all currencies at the same time.

F. EXCHANGE RATES
• Why Exchange Rates (weak home currency) May Not Correct a Balance-of-Trade
Deficit?
4. International trades are prearranged and cannot be adjusted immediately. The lag
time between weakness in the USD and the increasing trend in the non-US demand for
US products has been estimated to be 18 months.
5. International trade involves importers and exporters under the same ownership –
intercompany trade between parents and subsidiaries. Such trade amounts to more than
50% of all international trade, it will continue even if the home currency weakens.

2-4 INTERNATIONAL CAPITAL FLOWS
• USA MNCs engage in DFI the most.
• 50% to Europe, 30% in Latin America and Canada, 15% in Asia and the Pacific region
• Other top countries are the UK, France, Germany
• USA attracts about 1/6th of all DFI of (most in) the world
• These come from the UK, Japan, Netherlands, Canada and France
• Shell Oil (Netherlands), Canon (Japan), Allianz SE (Germany)
• Country that sends DFI also attracts DFI!

A. FACTORS AFFECTING DFI
1. Changes in Restrictions:
• New opportunities may arise from the removal of government barriers.
• In the 1990s, US-MNCs pursued aggressive DFI in the less developed countries (India,
Mexico, China, Chile, Argentina)
2. Privatization (https://www.youtube.com/watch?v=0wYHRWo2Ins ):
• DFI has also been stimulated by the selling of national operations to corporations
• It may increase the market value of a firm – managerial efficiency, wealth maximization
• In Chile: to prevent control by a small group of investors
• In France: to prevent a more nationalized economy
• In the UK: to spread stock ownership

A. FACTORS AFFECTING DFI
3. Potential Economic Growth:
• Countries with greater potential economic growth are morel likely to attract DFI
4. Tax Rates (https://www.insidermonkey.com/blog/5-countries-with-the-lowest-corporate-tax-rates-
922975/ ):
• Countries that impose relatively low tax rates on corporate earnings are more likely to
attract DFI.
5. Exchange Rate:
• Firms pursue DFI in a country when the currency is (cheap) weak and reaps the benefits
when it becomes strong in the future

B. FACTORS AFFECTING INT. PORTFOLIO INVESTMENT
• Tax Rates on Interest or Dividends:
• Investors will normally prefer countries where the tax rates are relatively low.
• Interest Rates:
• Money tends to flow to countries with high-interest rates – from Japan to the USA
• Exchange Rates:
• Foreign investors might be if the local currency is expected to be strengthened in the
future

C. IMPACT OF INTERNATIONAL CAPITAL FLOWS
• Without
International
Capital Flows
less funding
would be
available in
the USA and
the cost of
funding
would be
higher,
regardless of
a firm’s risk
level.
• This would
reduce the
number of
business

2-5 AGENCIES THAT FACILITATE INTERNATIONAL FLOWS
International Monetary Fund (IMF)
World Bank - International Bank for Reconstruction and Develop (IBRD)
World Trade Organization (WTO)
International Finance Corporation (IFC)
International Development Assistance (IDA)
Bank for International Settlements (BIS)
Organization for Economic Cooperation and Development (OECD)
Regional Development Agencies - ADB, IDB
Other Development Agencies

INTERNATIONAL MONETARY FUND (IMF)
• The IMF is an organization of 183 member countries. Established in 1946, it aims:
• to promote international monetary cooperation and exchange stability;
• to foster economic growth and high levels of employment; and
• to provide temporary financial assistance to help ease imbalances of payments
• Its operations involve surveillance and financial and technical assistance.
• In particular, its compensatory financing facility attempts to reduce the impact of
export instability on country economies.
• The IMF uses a quota system, and its unit of account is the SDR (special drawing
right).

WORLD BANK – IBRD, IDA, IFC, MIGA, ICSID, REGIONAL BODIES
• Established in 1944, the Group assists development with the primary focus of
helping the poorest people and the poorest countries.
• It has 183 member countries and is composed of five organizations - IBRD, IDA,
IFC, MIGA and ICSID.
• It has 183 member countries and is composed of five organizations - IBRD, IDA,
IFC, MIGA and ICSID.

WORLD BANK – IBRD
• IBRD – International Bank for Reconstruction and Development
• Better known as the World Bank, the IBRD provides loans and development
assistance to middle-income countries and creditworthy poorer countries.
• IBRD’s structural adjustment loans are intended to enhance a country’s long-term
economic growth.
• The IBRD is not a profit-maximizing organization. Nevertheless, it has earned a
net income every year since 1948.
• It may spread its funds by entering into co-financing agreements with official aid
agencies, export credit agencies, as well as commercial banks.

WORLD BANK – IDA
• IDA – International Development Association
• IDA was set up in 1960 as an agency that lends to the very poor developing
nations on highly concessional terms.
• IDA lends only to those countries that lack the financial ability to borrow from
IBRD.
• IBRD and IDA are run on the same lines, sharing the same staff, headquarters and
project evaluation standards.

WORLD BANK – IFC
• IFC – International Finance Corporation
• The IFC was set up in 1956 to promote sustainable private sector investment in
developing countries, by
• financing private sector projects;
• helping to mobilize financing in the international financial markets; and
• providing advice and technical assistance to businesses and governments.

WORLD BANK – MIGA, ICSID
• MIGA – Multilateral Investment Guarantee Agency
• The MIGA was created in 1988 to promote FDI in emerging economies, by
• offering political risk insurance to investors and lenders; and
• helping developing countries attract and retain private investment.
• ICSID – International Center for Settlement of Investment Disputes
• The ICSID was created in 1966 to facilitate the settlement of investment disputes
between governments and foreign investors, thereby helping to promote
increased flows of international investment.

WORLD BANK – WTO
• WTO – World Trade Organization: Created in 1995, the WTO is the successor to the
General Agreement on Tariffs and Trade (GATT). It deals with the global rules of trade
between nations to ensure that trade flows smoothly, predictably and freely. At the heart
of the WTO's multilateral trading system are its trade agreements.
• WTO’s functions are:
• administering WTO trade agreements;
• serving as a forum for trade negotiations;
• handling trade disputes;
• monitoring national trading policies;
• providing technical assistance and training for developing countries; and
• cooperating with other international groups.

WORLD BANK – REGIONAL AGENCIES
• Other Regional Development Agencies
• Agencies with more regional objectives relating to economic development include
• the Inter-American Development Bank
• the Asian Development Bank
• the African Development Bank
• the European Bank for Reconstruction and Development

IMPACT OF INTERNATIONAL TRADE ON AN MNC’S
VALUE
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E
CF
E
=
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E (CFj,t ) = expected cash flows in currency j to be received
by the U.S. parent at the end of period t
E (ERj,t ) = expected exchange rate at which currency j can
be converted to dollars at the end of period t
k = weighted average cost of capital of the parent
Exchange Rate Movements
Inflation in Foreign Countries
National Income in Foreign Countries
Trade Agreements

GUIDED HOMEWORK
• Analyze the trend of Bangladeshi Balance of Payment (BOP) over the last 10 years
• Top 5 products and services imported and exported.
• Top 5 countries from where import and export are made
• Chapter Problems
• 11, 12, 13, 14, 15
• Chapter Case
• Blades Inc. – Exposure to International Flow of Funds

International Flow of Funds (MTM).ppt

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