Factor flows and foreign exchange issues

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Case
Between 2003 and 2004, as the US dollar continued to weaken
against both the Euro and Yen, why did the Japanese central
bank spent 30 trillion yen to buy dollars?
Dollar alone was falling

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US trade in goods with Japan

All figures in Millions of USD

Year

Exports

Imports

Balance of
trade

2004

53,568.7

129,805.2

-76,236.5

2003

52,004.3

118,036.6

-66,032.4

Source: US Census Bureau

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Question
Was the Japanese approach fundamentally correct?
e.g. South Korea (from 2002-2005, won appreciated 30% against the
dollar)
Correct the economic fundamentals

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Session objectives
Understand how governments control the flow of currencies
across national borders
Examine the roles of different institutions in foreign exchange
Understand how exchange-rate movements influence
business decisions

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Case
The rupee had a free fall in 2013 when it lost over 19% against
the dollar. What possible measures could the Reserve
Bank/Government of India have adopted in arresting the fall?

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Sell forex reserves to buy rupees

Let a foreign country to buy rupees
Raise interest rates
Restrict the outward flow of Indian rupees

Rojers P Joseph - IIM Rohtak

 What did the Government/RBI do?

Raised interest rates
Restrict the outward flow of Indian rupee
Restriction on Indian firms investing abroad
Restriction on remittances by resident Indians
Tariffs on import of gold

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 Did RBI succeed?

Worsening current account deficit (CAD)
Trade deficit: $185 billion

Insufficient FDI inflows

Large FII outflows
Rising import bill
Lower GDP growth rate
Strengthening of dollar

Eventually, how did rupee appreciate significantly in 2014,

after almost a year?
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Balance of payments
The current account and the capital account together
constitute a nation's balance of payments

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The current account

Balance of trade: Export and import
Net earnings from investments: interest and dividend
Net cash transfers: Remittances, gifts and other unilateral
transfers

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The capital account

The capital account:

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Net Foreign direct investment (FDI): Long-term capital investment

Net Portfolio investments: Purchase or sale of shares and bonds
Other net investments: Loans, Capital flow into bank accounts
Net changes in the reserve account: Operated by the Central Bank to
buy and sell foreign currencies

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Payment/receipt in Capital/Current account?

(1) A German investors purchase of shares of TCS stock
(2) $5 million of foreign aid to Fiji
(3) An Indians purchase of an airline ticket from British
Airways
(4) A loan by an Indian bank to Kenya
(5) A Chineses purchase of Darjeeling Tea
(6) An Indian banks borrowing of dollars

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12

Daewoo and Asian Financial Crisis

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Precursor: the East Asian miracle

Asian Tigers: highly developed economies of Hong Kong,
Singapore, South Korea and Taiwan
Exceptionally high growth rates (double digits) and rapid
industrialization between the early 1960s and 1990s (NICs)
Highly educated and skilled workforce
Specialized in areas where they had a competitive advantage
Non-democratic and relatively authoritarian political systems
during the early years
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The Asian financial crisis?

July 1997: Depreciation of the Thai Baht
Crisis spread to S. Korea, Indonesia, Malaysia and the
Philippines
Singapore, Hong Kong and Taiwan were also affected
1998: crisis spread to Russia
complete financial, economic and political collapse

Spread to Latin America, particularly Brazil

Brazil survived with IMF funding

1999: situation improved

2000: complete recovery
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Source: IMF, World Economic Outlook
(October 1999)

16

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Core Issue
Financial crisis: Financial institutions or assets lose a large part
of their value
Debt burden
Depreciation of currency
Macro-economic policy induced crisis

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Questions
1. How would you describe Koreas economic system? What
are the key elements in that system? How would you describe
the interaction between politics and economics in Korea?
2. What were the key mistakes Kim Woo-Choong made in
formulating and implementing Daewoos strategy, and how
did the economic crisis in Korea and in the rest of Asia affect
that strategy?
3. Does Korea look like a good place to invest? Why or why
not?
4. What risks does GM face in taking over Daewoo Motors?
How can GM overcome them?

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Questions
How would you describe Koreas economic system? What are
the key elements in that system? How would you describe the
interaction between politics and economics in Korea?
Chaebols
Family owned businesses
Governments objective: export orientation
(Refer to the 3rd era in the evolution of international trade and investment)

Loans and other special favours

Strong cooperation between the state and the private sector
Charges of corruption

Concentration of economic power in a few

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The Korean economy prior to the crisis

Government: huge debt burden
External debt vs. internal debt
Firms as well as countrys

Banks: technically insolvent

Borrowed money in dollar terms
Preponderance of short-term finances in the capital structure

Bad loans

Chaebol: high rate of capital accumulation

Overextended Chaebols (vis--vis the fourth era of international trade
and investment)
large capital inflows and foreign investment in 1990s
Worsening D/E ratio

Led to excessive exposure to foreign exchange risk

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Forex reserves
Most of these countries had low forex reserves
The usable foreign exchange reserves of S. Korea had come down to
about $7 billion (of the value of 2 weeks imports) in November 1997

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In million dollars
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Summary
Weak regulatory framework in the Korean financial and
economic system
Internal economic and financial mismanagement and excesses
India and China were less affected by the crisis

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All values in millions of dollars

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Questions
Does Korea look like a good place to invest? Why or why not?
Not with
Devalued currency
Huge debts
Faltering financial institutions

Yes with the IMFs conditions

Banking reforms
Bankruptcy laws

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Questions
What are the key mistakes Kim Woo-Choong made in
formulating and implementing Daewoos strategy, and how
did the economic crisis in Korea and in the rest of Asia affect
that strategy?
Continued with the expansion plans
Added more debt
Issued corporate bonds
Could not service interest payments
Requested a moratorium on interest payments

Instability spread to international markets

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Questions
What risks does GM face in taking over Daewoo motors? How
can GM overcome them?
Financial risks?
Debt burden
The governments mandate on D/E ratio

Marketing risks?
Competing brands
Restoring market share

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The role of IMF

The rescue package organised by the IMF: $58 billion
$21 billion was the loan pledged by the IMF (the largest amount to be
lent to any country in a single deal till then)
The rest of the $58 billion included loans from the World Bank, the
Asian Development Bank and the Japanese government

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Why was India not affected by the crisis?

Full Capital Convertibility was not allowed.
Lock in Period for foreign investment in real estate.

Floating exchange rate with some influence by the RBI during

periods of crisis (Managed float).

Strong Fundamental growth with services sector being the prime

reason.

External Debt to GDP has been declining for the past few years.

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