Week 9: Best Practices 8

Ch8 Foreign Economic Cycles

Chater Openning Questions

A manager needs to:

Summary

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

Monetary policy around the world

• In many countries, monetary policy serves short run political interests. Countries vary in their underlying attitudes about the role of monetary policy.

Supply shocks in foreign countries

• Susceptibility to a supply depends on the country’s dependence on the material in short supply. Countries totally dependent on imported oil have a greater response to supply shocks than countries with some oil, like the U.S.

Commodity risk in small countries

• Countries whose economy is dependent on one or two commodities are prone to boom bust cycles caused by price fluctuation of those commodities.

Trading partner risk

• 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.

Foreign exchange risk

• 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.

Financial crisis in foreign countries

• Foreign exchange crises can wreck local businesses that were fundamentally sound. Foreign exchange controls that limit a corporations ability to move money around the world are often imposed during a crisis.

War and revolution

• Wars, coups detat, and assassinations pose serious risk to companies operating overseas. Thus, political stability must be evaluated carefully before making large foreign investments.

managing through the foreign business cycle

• A business that is producing goofs overseas for sale in the American market has a different set of problems than a business selling to the local market. Business strategy for a foreign recession varies depending on whether the company is selling got 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 U.S. downturn.

The monitoring system

• An early warning system should be established for every foreign country of importance to your company. 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.

Contingency plans

• 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.

Summing Up

• Economic fluctuations are more varied in certain foreign countries, especially less developed countries. For sales oriented companies its easy enough to sell in a number of countries. Production oriented companies should consider having offshore facilities in very different regions, such as one in Asia, one in Latin America, and one in Eastern Europe.

Economic terms

Explan 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:

• The Economist
• Fun economic videos

Explain the terms in your own words briefly.

Foreign Exchange Rate (page 180)

• The price of the domestic currency with respect to another currency.

Pegged Exchange Rate (page 180)

• A fixed exchange rate. A currency’s value is fixed by a monetary force against the value of another currency.

Floating Exchange Rate (page 183)

• A currency’s value is allowed to value in response to foreign exchange market events.

Currency Devaluation (page 183)

• Happens when a government makes monetary policy to reduce a currency’s value.

Currency Depreciation

• The loss of value of a currency with respect to one or more foreign reference currencies.

Foreign Exchange Control (page 183)

• Various forms of controls imposed by a government on the purchase of forgeing currencies by residence, on the purchase of local currency by nonresidents, or the transfers of any currency across national borders.

Purchasing Power Parity (page 192)

• The rates of currency conversion that try to equalise the purchasing power of different currencies, by eliminating the differences in price levels between countries.

Economic events

Describe the characteristics of the following events briefly.

“el error de diciembre”, the Mexican peso crisis of 1994 (page 183)

• In 1994, Mexico had been pegging the peso to the dollar at a ratio of three pesos per greenback. From one third of a dollar it fell to a value of one tenth of a buck. For American companies overseas, their first problem was that a peso of earnings translated into fewer American dollars. The overseas manager who was hitting her numbers in pesos suddenly was not hitting her numbers in dollars.

The Indonesian financial crisis of 1998 (page 184)

• The Indonesian financial crisis of 1998 showed how foreign exchange crises can lead to domestic recession. The manufacturing sector of Indonesia relied on bank credit for finance. Large firms borrowed money from international banks, and smaller firms borrowed money from local banks. The credit supported the working capital needs of the country’s manufacturers.

The Asian financial crisis of 1997-1998 (page 189)

• Malaysia instituted such restrictions in 1997, early in the Asian financial crisis. Foreign exchange controls are government restrictions on the movement of money, typically out of the country. The Asian financial crises led to a rethinking by Western lenders of the financial soundness of borrowers in Indonesia and elsewhere in Asia.