A manager needs to: Look for monetary policies to be a major cause of business cycles Do more preparations to achieve the same flexibility in foreign countries that is easily obtained in the US.
For a major industrialized country, the monitoring system would closely resemble that used in the United States with an addition of foreign exchange risk.
For a less developed country,
| Risk | Indicators |
|---|---|
| monetary policy | varies depending on individual countries |
| foreign exchange risk | divergence between PPP and actual exchange rate |
| capital control | country’s bond credit ratings and stock exchange prices |
| oil | know how dependent the country is on imported oil |
| commodity | commodity price |
| trading partner risk | know who the major trading partners are (including tourism) |
| war or rebellion | local press |
In many countries, monetary policy serves short-run political interests Countries vary in their underlying attitudes about the role of monetary policy *It may be wise to hook up with an economist in the foreign country. This could be a consultant or an analyst. This will make it easier to determine how monetary policy is conducted in the foreign country.
Susceptibility to a supply depends on the country’s dependence on the material in short supply, typically oil. Countries totally dependent on imported oil have a greater response to supply shocks than countries with some oil, like the United States. *The international business manager who sees world oil prices rising will want to take some time to look at how dependent on imported oil his key countries are.
Countries whose economy is dependent on one or two commodities are prone to boom-bust cycles caused by price fluctuation of those commodities. Price weakness can come from either of two directions: low demand or high supply. If you are a business manager selling products in a country dependent on one major product, you need to monitor that product. Risk of a key commodity booming or collapsing can work either for a company or against it. If the company is primarily selling in the foreign country, then high prices for the commodity are good, and low prices are bad.
*A country that has a large concentration of its exports to one other country is at risk if the key trading partner goes into recession.
Exchange rate fluctuations can make overseas profits translate into more dollars or fewer dollars. Exchange rate fluctuations can change the underlying profitability of overseas operations. Profit translation problems assume that there are profits. Swings in exchange rates can increase, decrease and even eliminate the profits of overseas operations. Forecasts of exchange rates are very unreliable.
Foreign exchange crisis can be severe, and wreck local businesses that were fundamentally sound. Foreign exchange controls that limit a corporation’s ability to move money around the world are often imposed during a crisis. A financial crisis occurs when a country no longer has the foreign exchange reserves or the credit that it needs to continue meeting its international obligations. Devaluation of the currency is a common result of a financial crisis. This is bad news for overseas business managers, because their money is now worth a lot less. *The financial crisis often leads to a recession in the foreign country.
Wars, coups of the nation (coups d’etat), and assassinations pose serious risks to companies operating overseas. Thus, political stability must be evaluated carefully before making large foreign investments. Wars are not good for countries. This is most true for countries that get invaded. Companies with production facilities suffer the most, because they are more valuable spoils of war than stores or distribution centers. Recession or severe depression may envelope a country embroiled in war. Companies that have substantial fixed assets are also at risk from revolutions and coups. *Revolution should be a red flag for businesses, whether they are producing or selling in the country.
Vendors who are mostly selling to locally owned businesses may be at risk of bankruptcy. Business strategy for a foreign recession varies depending on whether the company is selling to the local market or using the foreign country to produce goods for the home market. A recession strategy for firms selling to the foreign market should be much like one for dealing with a US downturn. A recession strategy for firms producing overseas for the home market should focus on ascertaining the viability of local suppliers and using the downturn to secure good deals. Business strategy in a foreign recession depends entirely on the nature of the business activity. The best strategy is based on knowing one’s vendors and knowing alternative vendors.
An early warning system should be established for every foreign country of importance to your company. Early warning systems for developed countries will resemble a US early warning system, with foreign exchange risk added. In less-developed countries, the system must also include the potential for foreign exchange crisis, war and political upheaval, commodity risk, and trading partner risks. Countries that are receiving a substantial amount of foreign investment can grow faster because of the capital inflow, but they are also more vulnerable to disruptions of the inflow. *The risk of war or internal rebellion is best monitored through the local and international press.
Contingency plans for a foreign recession should include the common elements of a domestic plan, plus plans for the various exchange rate and capital flow risks. Plans for alternative supply chains should be in place, including utility service. *For the company selling into a country at war, expect to experience weak consumer and business demand for discretionary projects.
Economic fluctuations are more varied in certain foreign countries, especially less-developed countries. They present a much larger challenge to the manager trying to monitor developments and assess risk. For sales-oriented companies, it’s easy enough to sell in a number of countries.
Explain each of the following terms in your own words. The author explains the terms in the textbook. If necessary, you may also Google the term on the Web. Good resources include:
Explain the terms in your own words briefly.
Foreign exchange rate is the price of the domestic currency with respect to another currency. The purpose of foreign exchange is to compare one currency with another for showing their relative values. I use this all the time when comparing the US currency to the Norwegian currency, which is bad right now.
A pegged exchange rate is a currency regime in which the country’s currency is tied to another currency, usually US dollars. The purpose here is to stabilize the value of the local currency, keeping it at a fixed rate in order to avoid exchange rate fluctuations.
A floating exchange rate is one that is determined by supply and demand on the open market. A floating exchange rate does not mean countries don’t try to manipulate their currency’s price.
*Currency devaluation is the deliberate downward adjustment of a country’s currency value. This means that the currency loses value
Currency depreciation is when a currency falls in value compared to other currencies. this can happen because of factors like economic fundamentals, interest rate differentials, political instability or risk aversion among investors.
Foreign exchange controls are various forms of controls imposed by a government on the purchase/sale of foreign currency by residents, on on the purchase/sale of local currency by foreigners, or the transfers of any currency across national borders.
Purchasing power parity exchange rate is the rate at which the currency of one country would have to be converted into that of another country to buy the same amount of goods and services in each country.
Describe the characteristics of the following events briefly.
The Mexican peso crisis was a currency crisis sparked by the Mexican government’s sudden devaluation of the peso against the US dollar in December 1994, which became one of the first international crises started by capital flight. Mexico had a new president who let the peso float, or sink. From one-third of a dollar it fell to one-tenth of a dollar. This especially hurt American companies overseas.
The manufacturing sector of Indonesia relied on bank credit for finance. Large companies would borrow from internationals banks, with their obligations in dollars. The Asian financial crises led to devaluation of the rupiah, and this presented large manufacturers from repaying their dollar-denominated loans to the large international banks. The sudden devaluation caused prices of all imported goods to skyrocket, and Indonesian families had less purchasing power, further aggravating the recession.
During the Asian financial crisis of 1997-1998, a number of Southeast Asian companies that were fundamentally sound went into bankruptcy because they could not meet their dollar-denominated debt payments. They were “fundamentally sound” because they could convert raw materials into finished goods at a reasonable profit margin. However, they were bankrupt because the value of their debt had skyrocketed, not through excessive borrowing but because their local currency had fallen relative to the dollar.