Module 1 - international business PDF

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MODULE 1 DEFINITION OF INTERNATIONAL BUSINESS: International business includes any type of business activity that crosses national borders. Though a number of definitions in the business literature can be found but no simple or universally accepted definition exists for the term international business. At one end of the definitional spectrum, international business is defined as organization that buys and/or sells goods and services across two or more national boundaries, even if management is located in a single country. At the other end of the spectrum, international business is equated only with those big enterprises, which have operating units outside their own country. In the middle are institutional arrangements that provide for some managerial direction of economic activity taking place abroad but stop short of controlling ownership of the business carrying on the activity, for example joint ventures with locally owned business or with foreign governments. Meaning of International Business International business is the process of implying business across the boundary of the country at a global level. It focuses on the resources of the globe and objectives of the organization on the global busines Scope of International Business

 Foreign Investments Foreign investment is an important part of international business. Foreign investment contain investments of funds from the abroad in exchange for financial return. Foreign investment is done through investment in foreign countries through international business. Foreign investments are two types which are direct investment and portfolio investment.  Exports and Imports of Merchandise Merchandise are the goods which are tangible. (those goods which can be seen and touched.) As mentioned above merchandise export means sending the home country’s goods to other countries which are tangible and merchandise imports means bringing tangible goods to the home country.  Licensing and Franchising Franchising means giving permission to the new party of the foreign country in order to produce and sell goods under your trademarks, patents or copyrights in exchange of some fee is also the way to enter into the international business. Licensing system refers to the companies like Pepsi and CocaCola which are produced and sold by local bottlers in foreign countries.  Service Exports and Imports Services exports and imports consist of the intangible items which cannot be seen and touched. The trade between the countries of the services is also known as invisible trade. There is a variety of services like tourism, travel, boarding, lodging, constructing, training, educational, financial services etc. Tourism and travel are major components of world trade in services.  Growth Opportunities There are lots of growth opportunities for both of the countries, developing and under-developing countries by trading with each other at a global level. The imports and exports of the countries grow their profits and help them to grow at a global level.  Benefiting from Currency Exchange International business also plays an important role while the currency exchange rate as one can take advantage of the currency fluctuations. For example, when the U.S. dollar is down, you might be able to export more as foreign customers benefit from the favourable currency exchange rate.

 Limitations of the Domestic Market If the domestic market of a country is small then the international business is a good option for the growth of the business in the host country. Depression of domestic market firms will force to explore foreign markets SPECIAL DIFFICULTIES IN INTERNATIONAL BUSINESS What make international business strategy different from the domestic are the differences in the marketing environment. The importance special problems in international marketing are given below: 1. POLITICAL AND LEGAL DIFFERENCES The political and legal environment of foreign markets is different from that of the domestic. The complexity generally increases as the number of countries in which a company does business increases. It should also be noted that the political and legal environment is not the same in all provinces of many home markets. For example, the political and legal environment is not exactly the same in all the states of India.

2. CULTURAL DIFFERENCES The cultural differences, is one of the most difficult problems in international marketing. Many domestic markets, however, are also not free from cultural diversity. 3. ECONOMIC DIFFERENCES The economic environment may vary from country to country 4. DIFFERENCES IN THE CURRENCY UNIT The currency unit varies from nation to nation. This may sometimes cause problems of currency convertibility, besides the problems of exchange rate fluctuations. The monetary system and regulations may also vary. 5. DIFFERENCES IN THE LANGUAGE An international marketer often encounters problems arising out of the differences in the language. Even when the same language is used in different countries, the same words of terms may have different meanings. The language problem, however, is not something peculiar to the international marketing. For example: the multiplicity of languages in India. 6. DIFFERENCES IN THE MARKETING INFRASTRUCTURE The availability and nature of the marketing facilities available in different countries may vary widely. For example, an advertising medium very effective in one market may not be available or may be underdeveloped in another market. 7. TRADE RESTRICTIONS A trade restriction, particularly import controls, is a very important problem, which an international market faces. 8. HIGH COSTS OF DISTANCE When the markets are far removed by distance, the transport cost becomes high and the time required for affecting the delivery tends to become longer. Distance tends to increase certain other costs also. 9. DIFFERENCES IN TRADE PRACTICES Trade practices and customs may differ between two countries. BENEFITS OF INTERNATIONAL BUSINESS SURVIVAL Because most of the countries are not as fortunate as the United States in terms of market size, resources, and opportunities, they must trade with others to survive; Hong Kong, has historically underscored this point well, for without food and water from China proper, the British colony would not have survived along. The countries of Europe have had similar experience, since most European nations are relatively small in size. Without foreign markets, European firms would not have sufficient economies of scale to allow then to be competitive with US firms. Nestle mentions in one of its advertisements that its own country, Switzerland, lacks natural resources, forcing it to depend on trade and adopt the geocentric perspective. International competition may not be matter of choice when survival is at stake. However, only firms with previously substantial market share and international experience could expand successfully. BALANCE OF PAYMENT The term Balance of Payments is very often referred to in the news and is always a hot topic for political and economic discussions across the globe. The term Balance of Payments is used in various contexts and in order to avoid ambiguity, it is essential to understand its meaning. According to V. Sharan, "Balance of Payments is a macro level statement showing inflow and outflow of foreign exchange." This means that it is a statement that records the flow of foreign exchange arising as a result of international economic transactions. International economic transactions include export and import of goods and services, unilateral transfers, FDI, foreign portfolio investments, etc. in and out of a country. A more comprehensive definition of Balance of Payments is provided by Cheol S. Eun and Bruce G. Resnik. According to them, Balance of Payments can be defined as, " the statistical record of a

country's international transactions over a certain period of time presented in the form of doubleentry book keeping." This definition shows that Balance of Payments statement has a time dimension that is, it is prepared over a certain time period which can be a quarter, a year, etc. Since BOP is a statement showing inflow and outflow of foreign currency in a country, all receipts from foreigners will be recorded as credit, bearing a positive sign. Receipts accrue to a country in case of exports (sale of goods and services abroad results in inflow of foreign exchange into the country), sale of financial and real assets. Likewise, all payments to foreigners will be recorded as debit, bearing a negative sign, indicating an outflow of foreign exchange. Payment of foreign exchange arises due to import of goods and services, purchase of financial and real assets. Thus, Inflow of foreign exchange +ve entry (CREDIT) Outflow of foreign exchange -ve entry (DEBIT) It is the difference between a nation’s total payments to foreign countries and its total receipts from them. In other words, it is a systematic record of a country’s receipts and payments in international economic transactions in a specific period of time. Balance of Trade: It is the difference between the money value of exports and imports of material goods [called visible items or merchandise) during a year. Examples of visible items are clothes, shoes, machines, etc. Clearly, the two transactions which determine BOT are exports and imports of goods. Exports and imports of services (invisible items like shipping, insurance, banking, payment of dividend and interest, expenditure by tourists, etc.) are not included. The difference between values of exports and imports is called Balance of trade or Trade balance. Remember export means sending goods abroad to earn foreign exchange whereas imports means buying goods from abroad and pay in foreign exchange. Exports are considered as income and imports as expenditure. It includes only visible items and does not consider exchange of services.

Components of Balance of Payments The BOP statement covers and records all types of international economic transactions that a country engages in over a certain time period. Based on the type of transactions, the BOP sub accounts are as follows: i. The current account ii. ii. The capital account iii. iii. Statistical errors and discrepancies iv. iv. The official reserves account

1 The current account The current account records all international economic transactions involving export and import of goods and services occurring within the current period. It has the following four sub categories: 1.1 Goods/ Merchandise trade: The export and import of goods is included in this subcategory of the current account. This is the most basic and traditional form of international economic transaction. The export of goods cause an inflow of foreign exchange into the country while the import of goods cause an outflow of foreign exchange from the country. Consequently, export of goods is recorded as a credit or +ve item in the BOP statement while the import of goods is recorded as a debit or a –ve item in the BOP statement. The difference between the export and import of goods is known as Balance of trade (BOT). If export of goods is more than the import of goods, the BOT is in surplus. On the other hand, if import of goods exceed the export of goods, the BOT is in deficit. Thus, Exports – Imports BOT Exports> Imports BOT surplus/+ve BOT Exports< Imports BOT deficit/-ve BOT 1.2. Services/ invisible Trade: This sub-category of the current account includes export and import of services. Services are intangible commodities. Since, they do not have a physical substance, service trade is also known as invisible trade. Common internationally traded services are transportation, tourism, financial charges for banking and insurance, royalties for intellectual property rights, constructions services, etc. The rendering or export of these services, entitles a country to receipt of foreign exchange and is therefore recorded as a credit or +ve item. On the other hand, the ulitization or import of these services, creates a foreign exchange payment liability and is hence, recorded as a debit or a –ve item. This sub-category of the current account has recorded the fastest growth for many industrial countries in the last two decades. 1.3. Factor Income: This sub-category of the current account includes income by way of interest and dividend on investments made abroad in previous periods. Eg. If an Indian company sets up a subsidiary in Singapore, the proportion of net income of the subsidiary (as dividend) is paid to the parent company(in India), in the current period, it shall be treated as current investment income for India. Also, wages and salaries to nonresident workers shall be included in this sub-category. 1.4. Unilateral Transfers: As the name suggests, this sub-category of current account includes one-direction flows. Unlike exports and imports, unilateral transfers are unrequited or unreciprocated flow of funds. Hence, there is no offsetting flow against unilateral transfers. Flow of funds by way of gifts, remittances, pension, foreign aid, official and private grants and other similar transfers against which no services are rendered or goods provided are included in this sub-category. Receipt of such transfers causes in inflow of foreign exchange and is recorded as a credit or +ve item and vice versa. The debit and the credit side of the various sub-categories of current account need to be balanced. If the credit side s bigger than the debit side, the difference is known as current account surplus and when the debit side is bigger than the credit side, the difference is known as current account deficit. A deficit in the current account is to be met by either of the following:  borrowings from foreigners, or  selling off past foreign investments. 2

The Capital Account/ Financial account . The capital account records all international economic transactions relating to investment in or withdrawal from financial assets and real estate. It reflects the flow of funds relating to

international loans, investments and banking funds. Investment in or purchase of financial and real estate abroad is recorded as a debit item in the capital account since it involves an outflow of capital. Likewise, sale of financial assets and real estate to foreigners is recorded as a credit item in the capital account since it results in receipt of foreign exchange. 2.1. Foreign Direct Investment (FDI): When a foreign investor acquires 10% or more of the voting rights of a domestic business, with an intent to control it, such an investment is called foreign direct investment or FDI. Eg. When the Japanese automobile manufacturer, Honda, built an assembly plant in Ohio, it made a foreign direct investment in Ohio. In the same way, acquisition of Carnation, a U.S. firm by the Swiss multinational, Nestle Corporation, amounted to FDI. Giant multinationals locating their production facilities in India, China and other Asian countries to benefit from cheap labor also amounts to FDI. When a country receives FDI, capital flows into the country and it is hence recorded as a credit or a +ve item in the capital account of the BOP statement. On the other hand, when a country makes FDI abroad, capital flight takes place. Hence, it is recorded as a debit or a –ve item in the BOP. 2.2. Portfolio Investment: This sub-category of the capital account includes the sale and purchase of foreign financial assets such as bonds, stocks, money market instruments, financial derivatives and the like which does not cause a transfer of control. Purchase of Indian financial assets by foreigners causes an inflow of foreign exchange and hence, it should be recorded as a credit or +ve item in the BOP statement. Likewise, Purchase of foreign financial assets by Indians causes a capital flight and hence, should be recorded as a debit or –ve item in the capital account. In the same way, withdrawal of investment in foreign financial assets by Indians causes an inflow of capital and withdrawal of investment in Indian financial assets by foreigners causes an outflow of capital. 2.3 Other Investments: This sub-category of capital account includes transactions in trade credit, currency, bank deposits, etc. 3 Errors and Omissions: This is an item in the BOP statement. It is also known as statistical discrepancy. It is considered while arriving at the overall balance. The statistical discrepancy in the BOP arises due to the following reasons: 3.1. Difficulty in data collection: Data for the BOP statement is collected from different sources and these sources differ in their approach of data compilation. Hence, statistics from different sources vary resulting in statistical discrepancy in the BOP statement. 3.2. Lead or lag transactions: Movement of foreign exchange may lead or lag the transactions that they are financing. Eg. If goods are shipped in March'2013 and payment for them is received in April'2013. The sent shipment will be recorded in the financial year ending 31st March'2013. However, payment for it shall be recorded in the following financial year ending 31st March'2014. This difference leads to statistical discrepancy in the BOP statement.. 3.3. Estimates: The BOP statement uses estimates to arrive at certain figures relating to travel, tourism, etc for which exact amounts are difficult to ascertain. Estimates are based on samples. If the sample chosen is defective, statistical discrepancy is bound to arise. 3.4. Unrecorded illegal transactions. Once statistical discrepancy is identified, the overall balance can be arrived at. The balancing between all credits and debits in the current account, capital account and the statistical

discrepancies represent the overall balance. If the overall balance is in surplus the surplus amount is used to repay borrowings from the IMF and the balance (if any) is carried to the official reserves account. If the overall balance is in deficit, the monetary authorities of the country arrange for capital flows via drawings from the IMF or official borrowings or by bringing down the foreign exchange reserves, to make good the deficit. Based on the above, capital account flows can be of two types: Accommodating capital flows and autonomous capital flows. Accommodating capital flows or above the line capital flows is the inflow of capital meant to cover the overall BOP deficit. The objective of such flows is to bring the BOP statement into equilibrium. It usually includes drawings from the IMF. Autonomous capital flows or below the line capital flows is the inflow of capital which occurs regardless of any deficit in the BOP. Eg. Foreigners repaying loan, FDI inflows in a country, etc. 4 Official Reserves Account: The official reserves account records monetary gold, SDR allocations to a country by the IMF and foreign currency assets held by the monetary authorities of a country. If the overall BOP is in surplus, the surplus gets added to the official reserves account. If the overall BOP is in deficit, the official reserves account gets reduced by the deficit amount, if accommodating capital flows are unavailable

PRINCIPLES OF BALANCE OF PAYMENTS The balance of payments is part of a larger system of social accounts recording the economic activity of an economy and its various sections. The social accounts related to economic transactions not only within the domestic economy but also between the domestic economy and the rest of the world. Balance of payments is concerned with economic transactions, Five basic types of economic transactions may be distinguished. They are: a) Purchases and sales of goods and services against financial items i.e. the interchange of goods and services against claims and monetary gold; b) Barter, i.e. the interchange of goods and services against other goods and services; c) The interchange of financial items against other financial items e.g. sale of securities for money, or the repayment of commercial debts in money; d) The provisions or acquisition of goods and services without requital, e.g. grants in 1aid; e) The provision or acquisition of financial items without requital, e.g. in payment of taxes or as a gift The social accounts have common rules of credit and debit for recording economic transactions. Credit entries ...