CHAPTER THREE

INTERNATIONAL FLOW OF FUNDS

 Introduction

 The transactions arising from international business

cause money flows from one country to another.
 The balance of payments is a measure of international
money flows.
 Financial managers of MNCs monitor the balance of
payments so that they can determine how the flow of
international transactions is changing over time.
 The balance of payments may signal potential shifts
in specific exchange rates.
 Thus, it can have a major influence on the long-term
planning and management by MNCs.
 Balance of payments
 The balance of payments is a summary of transactions
between domestic and foreign residents for a specific
country over a specified period of time.
 It represents an accounting of a country’s
international transactions for a period, usually a
quarter or a year.
 It accounts for transactions by businesses, individuals,
and the government.
Components of a balance-of-payments statement:
o Current account
o Capital account
o Financial account

For all three accounts, transactions that reflect inflows of

funds generate positive numbers (credits) for the
country’s balance whereas transactions that reflect
outflows of funds generate negative numbers (debits) for
its balance.
1. Current Account:

The main components of the current account are payments for:

 merchandise (goods) and services,
 factor income, and
 Transfers

2. Capital Account:
 The capital account category originally included the financial

account, which is now treated separately.

 The capital account includes the value of financial assets transferred

across country borders by people who move to a different country.

It includes the value of patents and trademarks that are
transferred across country borders.

3. Financial Account
The key components of the financial account are
payments for:
 direct foreign investment,
 portfolio investment, and
 other capital investment.
 Growth in international trade

 International trade has increased substantially over

time, which has strongly affected multinational
corporations.
o First, it has enabled some MNCs to obtain materials at lower
prices.
o Second, it has allowed many MNCs to increase their sales
and expand their operations.
The development of international trade is the result of
numerous efforts by governments to remove cross-border
restrictions.
1. Some of the more important historical events that
increased trade activity are.
 Fall of the Berlin wall in 1989
 Single European Act in the late 1980s
 North American Free Trade Agreement(NFTA) of 1993
 General Agreement on Tariffs and Trade (GATT) accord.
 Inception of the Euro in 1999
 Expansion of the European Union
 Other trade agreements

2. Outsourcing increased international trade

Factors affecting international trade flows
The most influential factors are:
o cost of labor,
o inflation,
o national income,
o credit conditions,
o government policies, and
o exchange rates.
1. Cost of labor: MNCs prefer to invest in countries
where the cost of labor is relatively cheap.
2. Inflation: If a country’s inflation rate increases
relative to the countries with which it trades,
 Consumers and corporations in that country will most
likely purchase more goods overseas (in response to
high local inflation), and
 the country’s exports to other countries will decline.
3. National income: As the real income level (adjusted
for inflation) rises, so does consumption of goods.
 A percentage of that increase in consumption will
most likely reflect an increased demand for foreign
goods.
4. Credit conditions: An unfavorable credit environment
may reduce international trade
 Make it difficult for some MNCs to obtain the funds
needed for purchasing imports.
 If banks fear that MNC will be unable to repay its
debt because of weak economic conditions then they
might refuse to provide letter of credit.
5. Government policies: Government policies can have a
major influence on which firms within an industry attain
the most market share worldwide.
These policies affect the legislating country’s:
o unemployment level,
o income level, and
o economic growth.
There are several types of policies often used to improve
the balance of trade and thereby to create jobs within a
country.
o Restriction on imports
o Subsidies for exporters
o Restrictions on piracy
o Environmental restrictions
o Labor laws
o Business laws
o Tax breaks
o Country trade requirements
o Government ownership or subsidies
o Country security laws
o Policies to punish country governments
6. Exchange rates: If a country’s currency begins to rise
in value against other currencies then its current account
balance should decrease, other things being equal.
 As the currency strengthens, goods exported by that
country will become more expensive to the importing
countries and so the demand for such goods will
decrease.
 Reflection

What do you think Ethiopia’s international

trade policy should be?
 International Capital Flows
 One of the most important types of capital flows is
direct foreign investment.
 Firms commonly attempt to engage in direct foreign
investment so that they can reach additional
consumers or utilize low-cost labor.
Factors affecting direct foreign investment
 Capital flows resulting from DFI change whenever
conditions in a country change the desire of firms to
conduct business operations there.
 Some of the more common factors that could affect a
country’s appeal for DFI are:
o Changes in restrictions
o Privatization
o Potential economic growth
o Tax rates
o Exchange rates
 Factors affecting international portfolio
investment

 The desire by individual or institutional investors to

direct international portfolio investment to a specific
country is influenced by a number of factors as
follows.
 Tax rates on interest or dividends
 Interest rates
 Exchange rates
Agencies that facilitate international flows
 A variety of agencies have been established to
facilitate international trade and financial
transactions.
 These agencies often represent a group of nations.
 A description of each of the more important agencies
follows.
1. International Monetary Fund(IMF):
 IMF was formed in 1944.
 The major objectives of the IMF, are to:
o promote cooperation among countries on international
monetary issues,
o promote stability in exchange rates,
o provide temporary funds to member countries attempting to
correct imbalances of international payments,
o promote free mobility of capital funds across countries, and
o promote free trade.
 It is clear from these objectives that the IMF’s goals
encourage the increased internationalization of
business.
 The IMF has played a major role in resolving
international financial crises.
 The IMF uses a surveillance system that closely
monitors national, regional, and global financial
conditions.
 It attempts to anticipate financial problems in member
countries and offers advice to these countries on how
they can reduce their exposure to potential crises.
 The IMF also provides technical assistance to
countries in order to help them implement effective
tax policies, exchange rate policies, banking systems,
and legal systems.
 Members are required to pay this assigned quota.
 The amount of funds that each member can borrow
from the IMF depends on its particular quota.
2. World Bank
 World Bank was established in 1944.
 Its primary objective is to make loans to countries
in order to reduce poverty and enhance economic
development.
 Its main source of funds is the sale of bonds and
other debt instruments to private investors and
governments.
3. World trade Organizations
 Established in 1993
 This organization was established to provide a forum
for multilateral trade negotiations and to settle trade
disputes related to the GATT.
 Member countries are given voting rights that are used
to render verdicts on trade disputes and other issues.
 World trade agreements have been signed among
countries, and these agreements provide the legal
foundation for facilitating international trade.
 Such agreements articulate how international trade
must be executed.
 MNCs are more willing to pursue international trade
when the rules are more transparent.
4. International Financial Corporation(IFC)

 In 1956 the IFC was established to promote private

enterprise within countries.
 Composed of a number of member nations,
 the IFC works to promote economic development
through the private rather than the government sector.
 It also purchases stock of corporations, thereby
becoming part owner in some cases in addition to a
creditor.
5. International development Association(IDA)
 The IDA was created in 1960 with country
development objectives similar to those of the World
Bank.
 However, its loan policy is more appropriate for less
prosperous nations.
 The IDA extends loans at low interest rates to poor
nations that cannot qualify for loans from the World
Bank.
6. Bank for international settlements(BIS)
 The BIS attempts to facilitate cooperation among
countries with regard to international transactions.
 It serves central banks of countries in their pursuit of
financial stability.
 It played an important role in supporting some of the
less developed countries during international debt
crises.
7. Organization for Economic Co-operation and
Development (OECD)
 The OECD facilitates governance in governments and
corporations of countries with market economics.
 It has 30 member countries as well as relationships
with numerous other countries.
 The OECD promotes international country
relationships that lead to globalization.
8. Regional development Agencies

There are several other agencies whose objectives

relating to economic development are more regional than
global.
These include:
o the Inter-American Development Bank: focusing on the needs
of Latin America
o the Asian Development Bank: established to enhance social
and economic development in Asia,
o the African Development Bank: focusing on development in
African countries
o the European Bank for Reconstruction and Development: was
created to help Eastern European countries adjust from
communism to capitalism.