International Finance for Developing Countries

© 2011 Lucky Yona. All rights reserved.

No part of this book may be reproduced, stored in a retrieval system, or transmitted by any means without the written permission of the author.

First published by AuthorHouse 8/11/2011

ISBN: 978-1-4567-7991-7 (sc)

ISBN: 978-1-4567-8170-5 (e)

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DEDICATION

This book is dedicated to six people whom God Sovereignty brought into my life:

Yona William and Emerentiana William, my parents

Joseph Kahugwa for your enduring and lasting friendship

Peter Songoma for your friendship, guidance and introducing me

to Jesus Christ my Saviour and Lord

Monica Kajange for your spiritual wisdom, encouragement and professional guidance that I cannot forget all days of my life

Werner Lindenblatt, my teacher at Umbwe High school for the hard lessons that gave me challenges and ability to see the need for more efforts in order to develop my career

ACKNOWLEDGMENT

I am humbled and appreciate the support of many academicians and professionals whom had interacted with them in the course of writing this book

My sincere thanks to all students I have taught (ESAMI/MSM Executives MBA) from Tanzania, Uganda, Kenya, Malawi, Zimbabwe, Swaziland, Namibia and Zambia for your invaluable contribution through class discussions. The privilege to teach you has been my research ground and through your wisdom and vast knowledge, this book contents will be useful to impart knowledge to other students and academicians across the whole world.

To all my professors at ESAMI, you did a great job of shaping my academic thinking. Thank you for your good job.

Special thanks to the Queen of my heart (Gloria), my sons (Lucky Jr, Timothy) and my daughter Faith for your support. You sacrificed your special time with me by allowing me spend more hours on this work. Thank you for your support.

I am indebted to authors and Publishers whose works are quoted in the text of the book and whose titles are listed in references.

PREFACE TO FIRST EDITION

This book intends to fill a gap on the non-availability of International Finance textbooks that address developing countries issues. In order to respond to this need, this book will address various topics on International Finance. As a textbook, it covers most of the theories and concepts in the field, clearly explains with practical application to developing countries environment and helps students to understand how the international finance concepts are applicable in the business world.

The book will meet the needs of students undertaking MBA courses and other professional courses in this field. The presentation of this book is in a simple language, which makes the course interesting and enjoyable to both students and managers in this field.

Lucky Yona

Contents

Preface To First Edition

Chapter 1 Introduction To International Finance

Chapter 2 International Monetary Systems

Chapter 3 International Financial Institutions

Chapter 4 African Regional Integrations

Chapter Five Global Financial Crisis And Its Impact On African Trade Capacity

Chapter 6 Foreign Direct Investment

Chapter 7 Africa Investment Climate

Chapter 8 Financial And Capital Markets

Chapter 9 Stock Exchanges

Chapter 10 Foreign Exchange Market

Chapter 11 Foreign Exchange Risk Management

Chapter 12 Money Laundering

Chapter 13 Foreign Debts

Chapter 14 Developing Countries Competitiveness

Chapter 15 Balance Of Payments

Chapter 16 Foreign Exchange Rates

Chapter 17 Internationalization Of Business In Developing Countries

1. INTRODUCTION TO INTERNATIONAL FINANCE

SKU-000463480_TEXT.pdf Topic Objectives

By the end of this chapter, students will be able to understand the genesis of International Finance and the major risks involved in international business.

SKU-000463480_TEXT.pdf Coverage

Introduction to international finance will cover

I. Introduction and definitions

II. Reasons for International finance`

III. Political risks in international business

IV. Foreign exchange risks

V. Market imperfections

VI. Expanded opportunity set

Practice questions

Selected References

SKU-000463480_TEXT.pdf Learning Outcomes

At the end of the topic, students should be able to evaluate and mitigate risks that are involved in international business.

CHAPTER 1

INTRODUCTION TO INTERNATIONAL FINANCE

1.1 Introduction

Over the last two decades, various changes have taken place across the world affecting the economies of countries, changing how businesses finance their activities and operate in the competitive world. We have also seen high level of business competitions due to the departure from the traditional business of monopolistic approach because of trade liberalizations policies and the higher growth of international trade among countries. We have also witnessed multinational corporations diversifying their production methods and operations, shifting the location of their production plants from host countries to different parts of the world. All these issues have affected business operations across the globe, thus creating a need to have a discipline that can help managers to manage all the risks associated with international business and trade.

In international business, two major issues pose problems to both parties involved. These issues involve foreign exchange risks and political risks. Whether the party is an importer who has to settle his obligations to the other party involved or a seller who has to receive money in foreign exchange from the other party involved, both of them are likely to experience foreign exchange risk and political risks problems respectively. The discussion of these two major problems will be in detail in this chapter.

1.2 Reasons for International Finance

International Finance as a discipline helps managers to understand the above-mentioned foreign exchange and political risks, which are involved in international trade and how to manage them. Without understanding the nature of these risks, managers will not know how to mitigate them. International Finance thus gives tools that can help to evaluate and mitigate them.

The other role of International Finance is that it helps managers to understand the market imperfections that are likely to affect international business operations. These market imperfections are the cause of a number of factors, which include legal restrictions, transportation cost, discriminatory taxation and information asymmetry among others. Awareness of these factors helps managers of multinational corporations to make a strategic shift of their production or market strategies from one country to another.

Knowledge of International Finance comes with the ability to see expanded opportunities that come with companies expanding their horizon of operation. Where companies start doing their business globally, a possibility of their market’s expansion is higher than when they only operate locally. This results in high diversification of business operations and investments.

1.3 Political Risks

Political risks arise when a local company extends its operation from its home country to a foreign country in terms of trade or investments. This is very common in the case of multinational organizations and transnational corporations from developed countries moving to less developed countries. These companies, because of having huge surpluses, large sums of money, and modern technology, they can shift their production centres to countries where there is cheap labour and market for their products. In due course, they are likely to face political risks that might lead to confiscation of their investments without compensation or with compensation by host countries.

Political risk is a governmental or societal actions and policies, originating either from within or outside the host country, and negatively affecting a select group of, or the majority of, foreign business operations and investments. Political risk arises from the fact that a sovereign country can change the rule of the game and the affected parties may not have effective recourse. Sometimes, political risks arise from direct host government action intended to drive investors out of the country.

Another common feature of political risk is the so called, creeping expropriation whereby a government decides to squeeze an investment by fixing higher taxes, or changing regulations or laws that have a direct negative impact on a project. In practice, governments may change the rules governing the tax system, royalties and contracts, which will ultimately increase the level of uncertainty faced by foreign companies operating in their countries. This practice is another source of political risk.

There are a number of examples of political risks across the globe that shows the confiscation of foreign investors’ assets and properties by the host government decisions. In 1967, Tanzania embarked on the socialism policy, which necessitated nationalizing all private properties of both foreign investors and local investors without compensation. In Uganda, during the regime of its former military leader, Idi Amin there was also a move to force foreign investors out the country and confiscate their investments. A move to attract the foreigners’ investors to come back in these countries has necessitated the re-appropriation of assets to the original owners after many years of negotiations.

Another recent example of political risks in developing countries is the case of Zimbabwe. In 2007, the Zimbabwe government decided to take over all farms owned by foreign investors and to distribute them to the locals. Britain and other foreign countries condemned this move. There was no compensation given to the original farmers who had already developed those farms. Zimbabwe ignored all the noises made by different countries after the decision to nationalize the farms. The case of Zimbabwe might be different simply because there were evidences of agreements between the two governments that required Britain to compensate the farmers.

The development of a democracy movement across the globe has is helping to reduce or minimize political risks as countries are forced to consider human rights and protect foreign investors. A country, which does not consider human rights, discourages foreign investors. In order to attract foreign investors, countries are required to comply with a number of International laws related to human rights as stipulated by various international organizations and conventions.

The dimension of political risks is not restricted to confiscation of properties by host countries, but rather extended to include the impact of international terrorism activities, which are likely to have direct impact to foreign investors’ properties. Another manifestation of political risks is the restrictions on maximum ownership of shares by foreigners, nationalization and control of local operations.

1.3.1. Categories of Political Risks

According to Hamada and Haugerudbraaten (2004), political risk takes three dimensions: expropriation, transfer, and political violence risk.

a. Expropriation risk refers to losses due to measures taken or approved by the host government that deprive the investor of its ownership or control over its investment, or, in the case of debt, result in the project enterprise being unable to meet its obligations to the lender.

b. Transfer risk refers to the inability to convert local currency (capital, interest, profits, royalties, and other remittances) into foreign exchange for transfer outside the host country.

c. Political violence risk refers to losses from damage to, or the destruction and disappearance of tangible assets, and politically motivated acts of war or civil disturbance in the host country, including revolution, insurrection, coups d’état, sabotage, and terrorism. It can be also be caused by an interruption of project operations essential to the overall project financial viability and obligations to lenders.

1.3.2. Assessment of Country Risks

In developing countries, political risks differ from one country to another. Some countries are more risky due to various reasons, which indicate the level of risk of the country. Those factors might change from period to period. Foreign investors would look on the political risk index indicators developed by various international organizations before embarking on the decision to invest in any of the developing countries.

One of the indicators of political risk is the political system and government system of a country. Some developing countries indicate a high level of political risks by having too many political parties, which pose risks of war because of power struggle to lead the government. . Typical examples indicate that in those countries accepting an election result has been a major problem, which has led to political havoc and civil wars.

Another indicator is the frequent changes in governments. This puts investors at high risks especially when new governments do not honour the agreements and contracts signed by previous governments. Foreign investors have lost many deals under these scenarios such that international organizations have ranked those countries as countries with high levels of political risks.

Inconsistent government policies are another indicator of high political risk. These inconsistencies are the result of frequent changes in government policies, which can jeopardize the interest of foreign investors. Such policies include policy on profit repatriations, employment, technology transfer and other policies that affect international business.

At the same time, those countries, which are isolated from the international community, are likely to pose high political risk. Their isolation is because of the fact that they lack integration into the world systems, they follow their own political system not needing mixing with other countries. In Africa, we have such countries like Libya, which usually follows its own rules and regulations. If a country is not a member of any international organization such as the World Trade organization (WTO), World Bank (WB), International Monetary Fund (IMF) and any other organization, it is likely to pose a high level of political risk, as it tends to operate on its own. In this case, those countries which are not members to any of these international organizations ignore the for example the conventions that require countries nationalizing investor’s properties to provide compensations. Countries with membership will normally nationalize with compensation. Membership to international organizations will be an indicator of low political risk to foreign investors.

There are different international organizations, which have come up with different indicators of political risks that provide guidance to all foreign investors who would like to invest in a foreign country. The above-discussed indicators are not all inclusive since there are many models, which use different indicators that are already been developed.

1.3.3. Causes of Political Risks

a. Civil and ethnic war

Civil wars in Africa are common causes of political risks, which have a direct impact on foreign firms’ operations.