International Financial

Management

GT
Pre WW-I financial order – 1816 - 1919
• Well-integrated financial order, sometimes known as the “first
age of globalization”
• widespread participation in the gold standard
• Unions like the Latin Monetary Union (Belgium, Italy,
Switzerland, France) and the Scandinavian monetary
union (Denmark, Norway and Sweden)
• Great Britain was at the time the world's pre-eminent financial,
imperial, and industrial power
WW-I to WW-II – 1919-1939
• Described as a period of "de-globalization", as both
international trade and capital flows shrank
• It was realized that the gold standard ran counter to the need to
retain domestic policy autonomy
• To protect their reserves of gold, countries would sometimes
need to raise interest rates and generally follow a deflationary
policy
• And then came the Great Depression in 1930
What happened in Bretton Woods?
Bretton Woods Conference - 1944
Bretton Woods Conference
• United Nations Monetary and Financial Conference,
meeting at Bretton Woods, New Hampshire (July 1–22, 1944),
during World War II to make financial arrangements for the
postwar world after the expected defeat of Germany and
Japan.
• Experts representing 44 states or governments, including
the Soviet Union
Bretton Woods Conference
• It drew up a project for the International Bank for
Reconstruction and Development (IBRD) to make long-term
capital available to states urgently needing such foreign aid,
and a project for the International Monetary Fund (IMF) to
finance short-term imbalances in international payments in
order to stabilize exchange rates.
• By the way, IMF was formed in 1945 at the Bretton Woods
Conference primarily by the ideas of Harry Dexter
White and John Maynard Keynes
White and Keynes at Bretton Woods Conference, 1944
Major agreements
• An adjustably pegged foreign exchange market rate
system: Exchange rates were pegged to gold. Governments
were only supposed to alter exchange rates to correct a
"fundamental disequilibrium.”
• Member countries pledged to make their
currencies convertible for trade-related and other current
account transactions.
Major agreements
• As it was possible that exchange rates thus established might
not be favorable to a country's balance of payments position,
governments had the power to revise them by up to 10%
from the initially agreed level ("par value") without objection by
the IMF.
• All member countries were required to subscribe to the
IMF's capital. Membership in the IBRD was conditioned on
being a member of the IMF. Voting in both institutions was
apportioned according to formulas giving greater weight to
countries contributing more capital ("quotas").
The Bretton Woods Era – 1944 - 1973
• The objective was to create an order that combined the benefits of an
integrated and relatively liberal international system with the
freedom for governments to pursue domestic policies aimed at
promoting full employment and social wellbeing
• The plan involved nations agreeing to a system of fixed but adjustable
exchange rates so that the currencies were pegged against the dollar,
with the dollar itself convertible into gold. So in effect this was a gold
– dollar exchange standard
• There was a desire from both the US and Britain not to see the
defeated powers (Germany and Japan) saddled with punitive
sanctions that would inflict lasting pain on future generations.
Washington Consensus – 1973 - Present

• Then US President Nixon suspended the dollar's

convertibility into gold in 1971, the United States'
abandonment of capital controls in 1974, and the UK's ending
of capital controls in 1979 which was swiftly copied by most
other major economies.
• Such liberalization brought significant benefits for large sections
of the population – most prominently with Deng
Xiaoping's reforms in China since 1978 and the liberalization of
India after its 1991 crisis.
Exchange rate regimes
Floating exchange rate system
• A floating exchange rate is a regime where the currency price of a
nation is set by the forex market based on supply and
demand relative to other currencies. This is in contrast to a fixed
exchange rate, in which the government entirely or predominantly
determines the rate
• A floating exchange rate doesn't mean countries don't try to intervene
and manipulate their currency's price, since governments and central
banks regularly attempt to keep their currency price favorable for
international trade.
• Floating exchange rates became more popular after the failure of the
gold standard and the Bretton Woods agreement
Managed (dirty) float regime
• It is a floating exchange rate where a country's central bank occasionally intervenes
to change the direction or the pace of change of a country's currency value
• In most instances, the central bank in a dirty float system acts as a buffer against an
external economic shock before its effects become disruptive to the domestic
economy
• The exchange rate is allowed to fluctuate on the open market, but the central bank can
intervene to keep it within a certain range, or prevent it from trending in an
unfavorable direction.
• Dirty, or managed floats are used when a country establishes a currency band or
currency board
• The goal of a dirty float is to keep currency volatility low and promote economic
stability
Fixed (pegged) exchange rate system

• Currency's value is fixed or pegged by a monetary

authority against the value of another currency, a basket of
other currencies, or another measure of value, such as gold
• In a fixed exchange rate system, a country’s central
bank typically uses an open market mechanism and is
committed at all times to buy and/or sell its currency at a fixed
price in order to maintain its pegged ratio and, hence, the stable
value of its currency in relation to the reference to which it is
pegged
Fixed (pegged) exchange rate system

• Most of the Caribbean islands—Aruba, Bahamas, Barbados, and Bermuda, to name a few—
peg their currencies to the U.S. dollar because their main source of income is
derived from tourism paid in dollars
• Fixing to the U.S. dollar stabilizes their economies and makes them less volatile
• In Africa, many countries peg to the euro. The exceptions being Djibouti and Eritrea which
peg their own currencies to the U.S. dollar. In the Middle East, many countries including
Jordan, Oman, Qatar, Saudi Arabia, and the United Arab Emirates peg to the U.S. dollar for
stability—the oil-rich nations need the United States as a major trading partner
for oil
• In Asia, Macau and Hong Kong fix to the U.S. dollar. China, on the other hand, has been
embroiled in controversy about its currency policy. While it does not officially peg the
Chinese yuan to a basket of currencies that include the U.S. dollar, it does manage it through
to benefit its manufacturing and export-driven economy
Crawling peg
• A crawling peg is a system of exchange rate adjustments in which a
currency with a fixed exchange rate is allowed to fluctuate within a band
of rates.
• The par value of the stated currency and the band of rates may also be
adjusted frequently, particularly in times of high exchange rate volatility.
• Crawling pegs are often used to control currency moves when there is a
threat of devaluation due to factors such as inflation or economic
instability. Coordinated buying or selling of the currency allows the par
value to remain within its bracketed range.
• Typically, crawling pegs are established by developing economies whose
currencies are linked to either the U.S. dollar or the euro.
 List of Countries

https://en.wikipedia.org/wiki/List_of_countries_by_exchange_rate_regime
IMF
• The International Monetary Fund (IMF) is an organization of 189 countries,
working to foster global monetary cooperation, secure financial
stability, facilitate international trade, promote high employment and
sustainable economic growth, and reduce poverty around the world.
• Created in 1945, the IMF is governed by and accountable to the 189 countries
that make up its near-global membership.
• The IMF's primary purpose is to ensure the stability of the international
monetary system—the system of exchange rates and international
payments that enables countries (and their citizens) to transact with each other.
The Fund's mandate was updated in 2012 to include all macroeconomic and
financial sector issues that bear on global stability.
IMF
• Economic Surveillance: The IMF oversees the international monetary
system and monitors the economic and financial policies of its 189
member countries. As part of this process, which takes place both at
the global level and in individual countries, the IMF highlights
possible risks to stability and advises on needed policy
adjustments.

• Learn how the IMF helped Vietnam.

IMF
• Lending: The IMF provides loans to member countries experiencing
actual or potential balance of payments problems to help them
rebuild their international reserves, stabilize their currencies, continue
paying for imports, and restore conditions for strong economic
growth, while correcting underlying problems.

• Learn how the IMF helped Ireland

IMF
• Capacity Development: The IMF works with governments around
the world to modernize their economic policies and institutions, and
train their people. This helps countries strengthen their economy,
improve growth and create jobs.

• Learn how the IMF helped Colombia

IMF

Timeline

https://www.imf.org/en/About/Timeline
IMF and Economic Reforms in India
Eurodollar
• The term eurodollar refers to U.S. dollar-denominated deposits at foreign banks
or at the overseas branches of American banks.
• Because they are held outside the United States, eurodollars are not subject to
regulation by the Federal Reserve Board, including reserve requirements.
• Dollar-denominated deposits not subject to U.S. banking regulations were
originally held almost exclusively in Europe, hence the name eurodollar. They are
also widely held in branches located in the Bahamas and the Cayman Islands.
• The fact that the eurodollar market is relatively free of regulation means
such deposits can pay higher interest. Their offshore location makes them
subject to political and economic risk in the country of their domicile; however,
most branches where the deposits are housed are in very stable locations.
Eurodollar
• The eurodollar market is one of the world's primary international capital
markets. They require a steady supply of depositors putting their money
into foreign banks. These eurodollar banks may have problems with their
liquidity if the supply of deposits drops.
• Most transactions in the eurodollar market are overnight, which means
they mature on the next business day. With weekends and holidays, an
overnight transaction can take as long as four days. The transactions
usually start on the same day they are executed, with money paid between
banks via the Fedwire and CHIPS systems. Eurodollar transactions with
maturities greater than six months are usually done as certificates of
deposit (CDs), for which there is also a limited secondary market.
Eurocurrency Market
• The eurocurrency market is the money market for currency
outside of the country where it is legal tender.
The eurocurrency market is utilized by banks, multinational
corporations, mutual funds, and hedge funds. They wish to
circumvent regulatory requirements, tax laws, and interest rate caps
often present in domestic banking, particularly in the United States.
• The term eurocurrency is a generalization of eurodollar and should
not be confused with the EU currency, the euro. The
eurocurrency market functions in many financial centers around the
world, not just Europe.
Eurocurrency Market
• There is also a eurobond market for countries, companies, and
financial institutions to borrow in currencies outside of their
domestic market.
• Eurocurrency markets can offer better rates for both borrowers and
lenders, but they also have higher risks.
• The eurocurrency market originated in the aftermath of World War II
when the Marshall Plan to rebuild Europe sent a flood of dollars
overseas. The market developed first in London, as banks needed a
market for dollar deposits outside the United States. Dollars held
outside the United States are called eurodollars, even if they are held
in markets outside Europe, such as Singapore or the Cayman Islands.
Eurocurrency Market
• The eurocurrency market has expanded to include other currencies,
such as the Japanese yen and the British pound , whenever they
trade outside of their home markets. However, the eurodollar market
remains the largest.
• Interest rates paid on deposits in the eurocurrency market are
typically higher than in the domestic market. That is because the
depositor is not protected by the same national banking laws and does
not have governmental deposit insurance. Rates on
eurocurrency loans are typically lower than those in the domestic market
for essentially the same reasons. Eurocurrency bank accounts are also not
subject to the same reserve requirements as domestic accounts.
Eurocurrency Market
• Euroyen - The offshore euroyen market was established in the 1980s and
expanded with Japan's economic influence. As interest rates declined in Japan
during the 1990s, the higher rates paid by euroyen accounts became more
attractive.
• Eurobond - There is an active bond market for countries, companies, and
financial institutions to borrow in currencies outside of their domestic markets.
• The main benefit of eurocurrency markets is that they are more
competitive. They can simultaneously offer lower interest rates for borrowers
and higher interest rates for lenders. That is mostly because eurocurrency
markets are less regulated. On the downside, eurocurrency markets face higher
risks, particularly during a run on the banks (Bank run).
Masala Bonds
• Masala bonds are bonds issued outside India but denominated in
Indian Rupees, rather than the local currency.
• Unlike dollar bonds, where the borrower takes the currency risk,
Masala bond makes the investors bear the risk.
• The first Masala bond was issued by the World Bank- backed IFC
in November 2014 when it raised 1,000 crore bond to fund
infrastructure projects in India.
• Later in August 2015 International Financial Cooperation for the
first time issued green masala bonds and raised Rupees 3.15
Billion to be used for private sector investments that address
climate change in India.
Balance of Payments
• The balance of payments (BOP) is a statement of all transactions made between
entities in one country and the rest of the world over a defined period of time,
such as a quarter or a year.
• The balance of payments include both the current account and capital account.
• The current account includes a nation's net trade in goods and services, its net
earnings on cross-border investments, and its net transfer payments.
• The capital account consists of a nation's imports and exports of capital
and foreign aid.
• The sum of all transactions recorded in the balance of payments should be zero;
however, exchange rate fluctuations and differences in accounting practices may hinder
this in practice.
Balance of Payments
• The sum of all transactions recorded in the balance of payments must be zero, as long as
the capital account is defined broadly.
• The reason is that every credit appearing in the current account has a corresponding debit in
the capital account, and vice-versa. If a country exports an item (a current account transaction),
it effectively imports foreign capital when that item is paid for (a capital account transaction).
• If a country cannot fund its imports through exports of capital, it must do so by running down its
reserves.
• This situation is often referred to as a balance of payments deficit, using the
narrow definition of the capital account that excludes central bank reserves. In reality, however,
the broadly defined balance of payments must add up to zero by definition.
• In practice, statistical discrepancies arise due to the difficulty of accurately counting every
transaction between an economy and the rest of the world, including discrepancies caused by
foreign currency translations.
Current Account
Visible:
• (Import – Export): Crude Oil, Cars, Mobiles, Computers, Gold etc.

Invisible:
• Services: Services refer to receipts from tourism, transportation (like the levy that
must be paid in Egypt when a ship passes through the Suez Canal), engineering,
business service fees (from lawyers or management consulting, for example), and
royalties from patents and copyrights.
• Receipts: From income-generating assets such as stocks (in the form of dividends)
• Unilateral transfers: These are credits that are mostly worker's remittances, which
are salaries sent back into the home country of a national working abroad, as well as
foreign aids that are directly received.
Current Account
Export (+ve) Import (-ve)

Goods Goods

Invisibles Invisibles

• Services (E.g. insurance, banking, consultancy etc.) • Services

• Income (E.g. Indians remitting money from abroad) • Import Invisibles

Unilateral transfers inflow (E.g. Gifts from one country Unilateral transfers outflow
to another)
M>X (Suppose Current Account Deficit)
Therefore, we require foreign exchange to meet this gap
Capital Account
• The components of the capital account include foreign
investment and loans, banking and other forms of capital, as well as
monetary movements or changes in the foreign exchange reserve.
The capital account flow reflects factors such as commercial
borrowings, banking, investments, loans, and capital.
• A surplus in the capital account means there is an inflow of money
into the country, while a deficit indicates money moving out of the
country. In this case, the country may be increasing its foreign
holdings.
Capital Account
Export (-ve) Import (+ve)

Lending Borrowings

Outflow of Assets Inflow of Assets

• Physical Assets • Physical Assets

• Financial Assets • Financial Assets

In case of Current Account deficit, we borrow more

(foreign exchange) to meet the gap