Changes in International Financial Markets
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What forces have brought a rapid change in the field of IFM?
Today’s financial reality is that fiat money knows no national boundary. We do live in a global village era. Development in one country or region can spill over across borders. One branch of study that consider the financial landscape is Financial Management (FM) which is mainly concerned with optimal financial decisions, such as those pertaining to corporate finance with a view to maximize shareholders’ wealth. In case of International Finance the objective becomes more complex and importance of Management is inevitable because it is intricate to determine exchange rate fluctuations and to forecast the cash flow. So, International Finance Management (IFM) is thus, essential for financial managers to fully understand vital international dimensions in the light of maximizing stakeholders’ wealth. Rapid Changes In International Financial Markets Brought About By:
- The Internationalization Phase
On the forefront, the greed to go international stems from the quest of being market seekers, raw material seekers and cost minimizers. Internationalization refers to the increasing importance of international trade, international relations, treaties, alliances and so forth. For these reasons, FM has expanded its global footprint. Included in this wave were the efforts to introduce a dramatic new commercial reality—the global market for standardized consumer products on a previously unimagined scale. Subsequently, IFM provides the required tools and expertise to deal with the international complexities encountered on the way.
- The Invisible Hand
According to neo-classical economics, the market, left of its own devices, will efficiently allocate goods, resources, and services. Promising to benefit the entire globe via unfettered trade and growth, Adam Smith, the father of “invisible hand”, argued that the basic forces of supply and demand will help allocate resources efficiently. Consequently, the notion of the free market has expanded and today it is practiced on a global scale thus, further fuels the practice of IFM.
- Advances In Technology
IFM gained momentum in the wake of a technological world. Technology has long been a crucial behind-the-scenes financial collaborator. On one side of the coin, online transactions allow for very fast movements of capital between countries, facilitating information dissemination, and clearance and settlement payments without the need of a physical marketplace – often in a matter of seconds. It reduces the cost of doing business internationally. On the flip side, these advances threaten to eclipse the international infrastructure. The importance of IFM is critically questioned when hackers have access to sensitive information with a few clicks of a computer mouse.
IFM came into being when various countries started opening their doors to each other. This phenomenon is well known as “liberalization” whereby entrepreneurshad the freedom to capitalizethe opportunity to step their foot in different parts of the world. The spark of liberalization was further aired by swift development in telecommunications and transportation technologies. The resultant of liberalization is today’s dynamic IFM.
Companies today operate on a global stage and can ignore this fact only at their peril. The term globalization is no longer a buzzword; it already transpired. For Khoo (2003), globalization is understood as the trans-boundary movements of capital, people, goods, information and culture, burst into intellectual awareness in the late 1980s and the 1990s. Globalization allows firms to view the world as one marketplace for all goods and services.
The impetus for globalized financial markets came from the governments that had begun to deregulate their foreign exchange and capital markets. For instance, in 1980 Japan deregulated its foreign exchange market. Perhaps the most celebrated deregulation occurred in London on October 27, 1986, and is known as the “Big Bang.” On that date, the London Stock Exchange eliminated fixed brokerage commissions. These changes were designed to give London the most open and competitive capital markets in the world. It has worked, and today the competition in London is especially fierce among the world's major financial centers. Deregulated financial markets and heightened competition in financial services provided a natural environment for financial innovations that resulted in the introduction of various complex and sophisticated derivatives products, in particular in over-the-counter (OTC) derivatives markets with interest rates and equities as underlying securities. While the leveraged nature of derivative instruments poses risks to individual investors, IFM provides scope for a more efficient allocation of risks.
After the Second World War, the outstanding ingredient influencing trends in IFM is integration. The boundaries between national markets rapidly became blurred leading to the emergence of a global unified financial market. Banks in major industrialized countries increased their presence in each other's countries considerably. Non-resident borrowers on an extensive scale are tapping major national market such as the US, Japan, Germany. Today both the potential borrower and the potential investor have a wide range of choice of markets. There are various challenges from the environment and accordingly the scope and relevance of IFM has increased in recent past.
- Capital Mobility
The international mobility of capital has benefited firms by giving them more financial options which has made international finance more dynamic and complex. Capital moves around the world in huge amount; corporations are free to access different markets for raising finance. The enormous opportunities of investments, savings, consumption and market accessibility have given rise to IFM. It is important to note that in IFM, stakeholders are spread all over the world.
This development allows investors to diversify their investment portfolios internationally. In the words of a recent Wall Street Journal article, “Over the past decade, US investors have poured buckets of money into overseas markets, in the form of international mutual funds. At the same time, Japanese investors are investing heavily in US and other foreign financial markets in efforts to recycle their enormous trade surpluses.
The economic integration and globalization that began in the eighties was picking up speed in the 1990s via privatization. Privatization is the process by which a country divests itself of the ownership and operation of a business venture by turning it over to the free market system. Additionally, privatization is often seen as a cure for bureaucratic inefficiency and waste; some economists estimate that privatization improves efficiency and reduces operating costs by as much as 20 per cent.
- Free- Trade Agreements And Rise of Regional Economic Blocs
The doctrine of comparative advantagestates that everyone gains if each nation specializes in the production of those goods that it produces relatively most efficiently and imports those goods that other countries produces most relatively efficiently. In this vein, during the post-war years, theGeneral Agreement on Trade and Tariffs (GATT, founded in 1947)was established in order to improve trade. It has played a key role in dismantling barriers (tariffs, subsidies, quotas) over the years, as a result of which international trade grew manifold. The financial participation of the trader's exporters and importers and the international transactions flowed significantly. It also created a permanent World Trade Organization (WTO), which has more power to enforce the rules. Also, The North American Free Trade Agreement (NAFTA) has give promoted international trade and given it a shape. These advancements put into the idea of FM both domestically and globally.
On the regional level, formal arrangements among countries have been instituted to promote economic integration. The European Union (EU) is a prime example. The EU includes 28 member states that have eliminated barriers to the free flow of goods, capital, and people. The EU is one of the most advanced forms of economic integration, a free trade area (like the NAFTA) is the most basic. Recently, however, the euro’s emergence as a global currency was dealt a serious setback in the midst of the debt crisis. It started in December 2009 when Greece revealed its budget deficit, surprising financial markets. The panic spread to other weak European countries, making borrowing and refinancing extremely costly and threatening the nascent recovery of the world economy from the global financial crisis of 2008. This debt crisis revealed a profound weakness of the euro as the common currency: the participating countries have achieved monetary integration, but without fiscal integration. Meaning that taxation, spending, and borrowing remain under control of national governments. Therefore, a lack of fiscal discipline in one country can become a Europe wide crisis. So, what has been the role of IFM? Even the effective use of IFM could not prevent the disaster.
- The Rise of MNCs
All because of liberalization and those international agreements, we have a buzz word called “MNC” i.e. Multinational Corporations. In the post WTO regime (after 1999 onwards), it has became pertinent to note that MNCs enjoy an edge over other normal companies because of its international setting and best opportunities with their world-wide. IFM has become an important wing for all big MNCs. Without the expertise in IFM it can be difficult to sustain in the market because international financial markets have a total different shape and analytics compared to the domestic financial markets. A sound management of international finances can help an organization achieve same efficiency and effectiveness in all markets. So far, so good!
- Foreign exchange risk
As discussed above that globalization opened new horizons, but it also brings companies to a variety of risks that they can face while operating in an international arena and in this regard IFM is the only solution to mitigate these risks. One such risk is foreign exchange risk Seventeen years ago, The Bretton Woods System gasped its final breath whereby the present International Monetary System set up is characterised by a mix of floating and managed exchange rate policies adopted by each nation keeping in view its interests. The foreign exchange risks states the variation in the prices of currency will have a tendency to convert a profitable deal to a loss making one.
If the only tool you have is a hammer, every problem looks like a nail. The wisdom of this old adage is just as applicable in risk management. IFM provides a variety of hedging techniques to control foreign exchange exposure since it jeopardizes profitability of all firms. They consider any use of risk management tools, such as forwards, futures and options that previously were virtually unknown. Financial innovation has played a role in promoting this unexpectedly good economic performance. At the same time, IFM has helped to raise global growth and to have made the economy more flexible and more resilient.
The foremost rapid changes in IFM have been the accelerating globalisation and integration. These developments have been fostered by the liberalisation of markets, rapid technological progress and major advances in telecommunications. Further the scope of IFM has widened its horizon with mechanism supported by multilateral trade agencies like WTO- and regional blocks like ASEAN, NAFTA, EU etc and the emergence of innovative financial instruments.
In view of globalization and its impact on the economy of the world, it is pertinent to note that the theory and practice of IFM is in consonance with the tax environment, legal obligations, foreign exchange rates, interest rate fluctuation, capital market movements, inflationary trends, political risk and country risk, micro and macroeconomic environment changes, ethical constraints etc. These problems can be managed through proper adaptation of IFM methodologies. IFM is crucial to the success of every multinational business because the increase in complication and challenges for managers.
The current scenario and outlook for evolution of the IFM registered sharp deterioration over the last years. To a great extent, the unfavorable environment is a result of cutbacks in net inflows of private capital. Among the factors responsible one could list the slow pace of world economic recovery, particularly in the United States in the wake of the 2007 recession; Ponzi scheme frauds; forecasts of lower business profits; reductions in consumer confidence; and accentuated growth in risk aversion on the part of investors.
Online EBook: Eun−Resnick: International Financial Management, Third Edition I. Foundations of International Financial Management. © The McGraw−Hill Companies, 2004
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