INDIA'S ECONOMICS.   Term Paper ID:24329 Click to get this paper

Essay Subject: Analyzes economic stability, govt. strategy, foreign exchange, derivatives & more to measure risks & opportunities for business investment. Charts.... More...

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Paper Abstract: Analyzes economic stability, govt. strategy, foreign exchange, derivatives & more to measure risks & opportunities for business investment. Charts. Paper Introduction: Introduction When considering the type of investment appropriate for entering a foreign country (joint venture, direct investment, licensing, for example), it is critical to consider the political stability of the target nation, the demographics of the country, and the economic and legal environment. Some nations have significant restrictions on foreign direct investment while others invite the inflow of economic activity such investment brings. This research considers the environment associated with India and how best to invest in that nation. Balance of Payments India had a deficit of $3.6 billion in balance of payments for 1991-1992. The United States is the principal source of imports to India, while Russia was the principal destination for exports during 1990-1991. Text of the Paper: The entire text of the paper is shown below. However, the text is somewhat scrambled. We want to give you as much information as we possibly can about our papers and essays, but we cannot give them away for free. In the text below you will find that while disordered, many of the phrases are essentially intact. From this text you will be able to get a solid sense of the writing style, the concepts addressed, and the sources used in the research paper. When the loan comes due, it will bepaid for with the rupees due from the importer, and the proceeds from theinvestments can be used to pay interest. However, many of these privatetransfers are believed to be moved abroad through illegal transactions. This can prompt fears among managers that stockholders and othersinterested in the company's performance may conclude that management is notdoing its job because of the loss when the loss is not the result ofmanagement activities (necessarily) but instead is due to fluctuations inthe exchange rate. [2]Country Commercial Guide-India, Washington, DC: U.S. So long as thecontract requires a lower price than the purchase paid for it, money ismade; however, if the currency being purchased has increased in valuerelative to the other currency, the holder of the contract suffers a loss. [5]J. At the same time, the foreign interest needs to be watchful of thevalue of the rupee, which suffered continuing devaluation in 1996.[18]Market hedges and derivatives can be used to help the company maintain acurrency position which insulates it against the movement of the rupee, andthere is some benefit to be gained from additional foreign investment inthe country. "India's Weak Industrial Production May Keep Growth Below 4% Forecast." Journal of Commerce and Commercial, January 27, 1994, 3A.Country Commercial Guide-India. Some of the same hedging techniques used in transaction riskmanagement can be applied to translation risk management, but there areother techniques that are generally more favorable. [11]Deirdre McMurdy and Andrew Willis, "Shifting Ground," Maclean's,2 March 1995, 29. "Rewards Available to Currency Futures Speculators." Economic Record, June 1992, S1 5-S116.Zhou, Su. [6]"Mr. Othermajor trading partners include the United Kingdom, Germany and Japan.[1]India's balance of payments remained strong in 1994 and 1995, with privatetransfers estimated at $6 billion. In this way, the real exchange rateis insulated somewhat from possible equalization through internationalexchanges. However, some of the credit for this achievementmust be given to the International Monetary Fund (IMF) which placedspecific requirements on the nation when it provided assistance to Indiaduring its 1991 crisis. "Trading the Wide World of Foreign Exchange." Futures, April 1995, 62-65.Taylor, Stephen J. [14]Stephen Taylor, "Rewards Available to Currency FuturesSpeculators," Economic Record 68 (June 1992): S1 7. When considering how best to accomplish this investment, a jointventure offers the greatest potential. TheIndian market is characterized by a few families which control mostindustries, and working with companies within these families makes marketaccess easier for the foreign company. However, it is not realistic of companies to expect thatexchange rates will not change, although criticism that losses or gainsshould be noted only when actually realized is a legitimate concern. The transaction risk is now on themultinational company. [15]David Smith, "How to Manipulate the Markets," Management Today,February 1995, 21. Thisis in contrast to noting them as they occur, which can be particularlyvolatile in some economies and representative of "paper" profit or losses. [21]Ibid. India, with itsburgeoning population and its commitment to improving its economy,represents a strong market for most companies. [18]Aparisim Ghosh, "Droopy Rupee," Far Eastern Economic Review,February 22, 1996, 58. Department of State,1994, 3. By working with an establishedIndian company, the foreign corporation is able to gain access to marketsand contacts which are critical to long-term success in the region. [8]Ibid. From this standpoint, the derivative is essentially a hedgingdevice against the vagaries of the market.[13] However, as with other contracts, the derivatives can be sold to thirdparties with no direct interest in the currencies in question, but with amerely speculative interest. Singh Goes for Broke." The Economist, March 5, 1994, 37.Nusbaum, David. They can use back-to-back loans to fundsubsidiaries, or they may choose one of the international capital markets,including New York, London, Zurich, or the Cayman Islands, among others.Each market offers particular advantages and disadvantages at any point intime, and the price and cost associated with one market vary widely bothwith other markets and over time. The United States is the principal source of imports to India, whileRussia was the principal destination for exports during 199 -1991. Clift, "India's Weak Industrial Production May Keep Growth Below4% Forecast," Journal of Commerce & Commercial, January 27, 1994, 3A. India has many different duties on stainless steel (where mostcountries only have one) depending on whether the steel is converted topressure vessels, cutlery or some other use. [9]Ibid. [3]Background Notes-India, Washington, DC: U.S. [4]"Look Out, Asia: India," The Economist, June 26, 1993, 34. This secondary market for derivatives is whatgets investors into trouble as they are not benefiting from the change inrates the same way that the companies who originally entered into thecontract are doing, or would be doing if they saw the derivative through toits conclusion. A credit or money market hedge involves borrowing against the amountin question in order to make a profit over the time period in question. ||Foreign Debt Stock ($Million) |9 ,723 |9 ,5 |92, ||Debt Service Ratio |25% |27.5% |28.2% | BibliographyClift, J. A forward hedge is essentially a derivative contract with thecurrencies in question serving as the measure of the contract. For example, a company which benefits if the dollar increasesmight enter into a derivatives contract with another company which suffersfrom high dollars, but benefits from strong rupees. This comes about as the nominal exchange rate ismultiplied by the ratio of the price index of a highly productive nationcompared to a less productive nation. Department of State, 1995, Gopher://gopher.state.gov/ ftp%3aDOSFan% 3aGopher%3a12%2 Business%2 Affairs%3a 4%2 Country% 2 Commercial%2 Guides%3aIndia%2 Commercial%2 Guide."Devalued: South Asia." The Economist, November 4, 1995, 38-39.Europa World Year Book. ----------------------- [1]Europa World Year Book, London: Europa Publications, Ltd., 1996,1394. In this way, there is no currency exchange risksince the companies will repay their loans in the same currency as it wasreceived.[15] Capital Market Risk When seeking to raise capital, multinational organizations have a widerange of options open to them. An examplecan be provided by a multinational company which sells goods to a foreignimporter. "Shifting Ground." Maclean's, 2 March 1995, 28-3 ."Mr. India has announced plans to borrow additionalfunds from the IMF, and the IMF has indicated that it would like to seeIndia reduce its deficit to 3 percent of GDP.[8] Because of its success in attracting foreign investment, India hasalso announced plans to repay $1.4 billion in old loans to the IMF ahead ofschedule, using excess reserves to reduce its foreign debt. However, these positive moves, designed to encourage foreigntrade and stimulate the economy, were announced against an increase in thebudget deficit, which climbed to 7.3 percent of GDP.[6] The budget also included a reform of tax concessions for variousduties. India is not as safe a foreign investment as Western Europeannations from the standpoint of currency fluctuations, but neither is it asrisky as other developing economies. The multinational company may accept that the importer will payat some future date the agreed upon amount in the agreed upon currency. Similarly, if reverse conditions are present, companies may want todelay payment for as long as possible in order to take full advantage ofthe exchange markets. Asa result of the large inflow of such funds in the 1994 to 1995 period,India's international foreign reserves, excluding gold, rose to $21.1billion, a substantial increase from the $15.5 billion in the previousyear.[2] Recent Changes in Government Strategy The government which came into power in 1991 substantially changed theeighth Five-Year Plan to cover the period from 1992-1997 instead of theoriginal period of 199 -1995. Foreign debtis a problem for India: in 1995, debt service payments will represent morethan half of the government's current spending. Department ofState, 1995, Gopher://gopher.state.gov/ ftp%3aDOSFan%3aGopher%3a12%2 Business%2 Affairs%3a 4%2 Country%2 Commercial%2 Guides%3aIndia%2 Commercial%2 Guide. Initially, the central bank took no steps to slowthe declining rupee, but later in the year, the central bank propped up thefalling currency. [2 ] This lessens the dependence on any onetrading partner. Therefore, this companyshould take on the issue of participating in the Indian market. Multinationals received some concession from the Financial AccountingStandards Board (FASB) in 1981 when FASB 52 replaced FASB 8 with regard totranslation risk, minimizing the effects of translation on financialstatements. Companies can, and do, enter intocontracts with companies in various parts of the world, and the secondarymarket for derivatives is similarly unconcerned with national boundaries. Inthe above example, the American company might borrow 1 million rupeesfrom a Indian bank on the same day that the sale is completed and investthose funds for the 18 -day period. Transaction Risk Transaction risks usually involve a receivable or payable denominatedin a foreign currency, and commonly arise from a transaction such as apurchase from a foreign supplier or a sale to a foreign customer. India's rupee is a "managed float" currency which saw a devaluation often percent during 1995. Derivative contracts are not currently regulated, and theyare not limited to a single nation. [2 ]Ibid. [16]Su Zhou, "The Response of Real Exchange Rates to Various EconomicShocks," Southern Economic Journal 61 (April 1995): 938-939. This research considers the environment associated with India and how bestto invest in that nation. Exhibits The following charts show the amount and source of foreign directinvestment in India for the years 1992 through 1994 (in millions of$US).[19] Plotted on a logarithmic scale, the first chart illustrates thatalthough foreign investment increased substantially during that three-yearperiod, the increase from 1993 to 1994 was not as significant as theincrease over the preceding period: [pic] The following charts illustrate increasing numbers of foreign nationsparticipating in its economy. Later on, the exchange may be reversed, with a profit beingmade if the rates have fallen. This economicenvironment has helped the nation take bold steps as it approaches the mid-point of its current Five-Year Plan.[4] Continued economic reform is neededin the financial services sector, infrastructure and labor segments if thecountry is to realize economic growth.[5] Current Economic Strategy The budget that was announced in February 1994 cut the maximum customsduty from 85 percent to 65 percent, reduced the corporate tax from the low5 percent level to a single rate of 46 percent, reduced the top income taxrate from 44.8 percent to 4 percent, and made the rupee convertible forcurrent account transactions (such as travel and education). The first is whether to participate in the nation's market atall, and the second is how best to take on the operations. So long as the American companyis able to secure higher returns than the interest rate on the loan, thereis protection against a decline in the currency rate. If the rates move so that the rupee loses againstthe dollar, moving to perhaps 11 to the dollar, the American company willreceive only $9 9,9 9 rather than the $1 million it expected. Inflation fell from 17 percent to 6.1 percent from 1992-1993, andGDP increased 4.2 percent during the same period. This crude type of exchange is the one thatmost tourists are familiar with. Choosing the appropriate capital marketcan help companies find investors interested in their offering. The importer agrees to pay the multinational 1 million rupees in 18 days. ||Real GDP Growth |3.5% |5.3% |5.5% ||Per Capita GDP ($) |281.7 |32 .3 |355.5 ||Gov't Spending as % of GDP |18% |17.8% |16.4% ||Inflation |1 .8% |1 % |9% ||Unemployment |22.5% |22.5% |22.5% ||Foreign Exchange Reserves |15,476 |21,135 |2 ,2 ||($Million) | | | ||Change in CPI |7.5% |9% |12% ||Average Exchange Rate ($=Rs) |31.37 |31.37 |32. An importer in a country whose currency is expected to depreciate interms of the currency of the supplier is motivated to purchase the foreigncurrency as soon as possible in order to get the most favorable rate ifpayment is due in the currency of the exporter; this is currently thesituation with regard to India. Such speculation can leave both companies in poor positionsif economies worsen or the currencies do not perform as expected.[12] In their most basic form, derivatives (a special form of contract) area way in which companies can seek shelter from the fluctuations of themarket. [7]Ibid. To protect itself from this risk,companies can engage in various types of hedging, including a forwardhedge, a credit or money market hedge, or the company may choose toaccelerate or delay payment. Thusan American multinational might have a subsidiary in the United Kingdom,and an English multinational might have a subsidiary in the United States.With back to back loans, each multinational loans an agreed upon figure, inthe home currency, to the subsidiary of the other multinational at thecurrent exchange rate. The main focus of the plan remained thesame, with an emphasis on economic liberalization, reduction ofunemployment and export promotion. [19]Country Commercial Guide. Singh Goes for Broke," The Economist, March 5, 1994, 37. Thegovernment's new budget also set a limit on the amount of money that can beprinted to meet the fiscal deficit, a move seen as significant byobservers. The amount of money involved is greater than the loss thecompanies would face if they had no such protection, and presumably lessthan the benefiting companies gain from the increase in the favoredcurrency. Translation Risk Where transaction risk refers to the risk associated with changes incurrencies over the period of a single transaction, translation risk refersto the risk that multinational organizations take on when they must statetheir financial position in terms of a single currency, their "home"currency, on financial statements.[14] In this way, a company which has a given amount in a bank in a foreigncountry and who maintains that balance over the course of the year may findthat due to exchange rates, the balance falls when translated into dollars. Thetransaction (purchase or sale) carries a risk that the currency value willchange; hence the term transaction risk. However, the Gulf War substantiallydamaged India's economy by increasing the price of oil, which was followedby a surge in inflation, a deterioration in the balance of payments, anincrease in foreign debt and an increase in the budget deficit.[3] The government's steps have resulted in a decrease in the budgetdeficit, which fell from 8.3 percent to 4.7 percent of GDP from 199 to1993. In this way, both the buyer and seller benefit sincethe seller is assuming that the currency in question will increase in valuewhile the buyer has the use of the funds for some period of time, and canpresumably make more interest than will be lost due to currencyfluctuations. [17]"Devalued: South Asia," The Economist, November 4, 1995, 38. Introduction When considering the type of investment appropriate for entering aforeign country (joint venture, direct investment, licensing, for example),it is critical to consider the political stability of the target nation,the demographics of the country, and the economic and legal environment.Some nations have significant restrictions on foreign direct investmentwhile others invite the inflow of economic activity such investment brings. However, themultinational could enter into a contract with a third party to sell 1 million rupees to the party in exchange for $1 million in 18 days.Assuming that the hedge carries with it a premium of one percent (to coverthe buyer against changes in the rate), the multinational will receive$99 , in exchange for 1 million rupees. Washington, DC: U.S. The new budget reduced thenumber of these duties by two-thirds.[7] Previous reforms in currency are credited with the increase of foreign-exchange reserves, which reached $13 billion in February 1994, up from $5billion in February 1993. and Amir Tavakkol. "The Response of Real Exchange Rates to Various Economic Shocks." Southern Economic Journal, April 1995, 936-954. Influences on Exchange Rates Any number of factors can affect currency rates: productivity, oilprices, domestic and foreign government spending, and monetarydifferentials. One of these includesback to back loans, where two multinational companies based in twodifferent countries have subsidiaries located in the other country. London: Europa Publications, Limited, 1996.Fatemi, Ali M. Inorder to cover the transaction risk, the multinational then may sell theagreed-upon amount to a third buyer, who sells the currency in question tothe importer at the same time. [pic] [pic] Key Domestic Economic Statistics The following economic statistics are provided as a guide to economicactivity within India during recent years.[21] | |1993-1994 |1994-1995 |1995-1996 ||Nominal GDP ($Billion) |25 .7 |29 .8 |329.2 ||GDP in local currency (Billion) |2613.2 |2751.7 |29 3. [16] The higher a nation's productivity, the stronger itscurrency tends to become. An exporter who expects the currency ofthe purchasing country to drop would want payment as soon as possible ifthe currency of the importer is being used in order to minimize transactionrisk. [12]Ali Fatemi and Amir Tavakkol, "Forward Risk Premium and theMaturity of Contracts," Review of Financial Economics 2 (Fall 1992): 94. These contracts are sometimes taken on by companies which do businessin multiple countries with their customers, where the customer agrees topay for goods at some point in the future and in the currency of thecompany's choosing. Balance of Payments India had a deficit of $3.6 billion in balance of payments for 1991-1992. However, because of the large sums ofmoney that are typical of most foreign exchange transactions, littlephysical money actually changes hands; instead, the transactions arehandled by computer which electronically credits and debits the requisiteaccounts based on internal calculations made after sampling rates from theworld's markets.[1 ] Most speculation instruments include a contract where the holder ofthe contract agrees to pay a certain amount of one currency for a givenamount of another currency at a certain date.[11] At this point, thecontract itself can often be bought and sold prior to the date that itcomes due, with the result that parties well removed from the originalcontractor may end up with the contract at the end. As more money has come into the nation (a result of thestance of the government inviting foreign direct investment), the rupee hasremained relatively strong; the devaluation of 1995 was seen by manyobservers as a reaction not so much to India's internal policies as to theMexican debt crisis occurring at the same time.[17] Recommendation There are two issues confronting a company considering opportunitiesin India. Through careful management of thejoint venture and the currency issue, the company should be able to realizeshort-term market share and long-term profitability from this internationalventure. [1 ]David Nusbaum, "Trading the Wide World of Foreign Exchange,"Futures, April 1995, 62. "Forward Risk Premium and the Maturity of Contracts." Review of Financial Economics 2 (Fall 1992): 93-97.Ghosh, Aparisim. [13]Ibid. The country is in theunenviable position of having to borrow additional funds merely to serviceold debt; any reduction that the country can realize in this debt becauseof early paybacks would certainly help its situation.[9] Managing Foreign Exchange Risk The simplest type of foreign exchange transaction is that which occurswhen the currency of one country is physically exchanged for the currencyof another. For example, an American multinational might agree to sell $1 millionin goods to an importer in India and the current exchange rate might be 1 rupees to the dollar. "Droopy Rupee." Far Eastern Economic Review, February 22, 1996, 58."Look Out, Asia: India." The Economist, June 26, 1993, 34-35.McMurdy, Deirdre and Andrew Willis. If the dollarincreases against the rupee, the first company pays some amount to thesecond company; if the rupee gains against the dollar, the second companypays the first. 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