Unit 3: Global Business Environment

Political environment:
Politics is a universal social activity. Government, on the other
hand, is concerned with the pursuit and exercise of power.
The power is exercised to make laws and decisions, which affect
the lives of a substantial number of people.
The exercise of power by the government is based on the
ideological foundation.
Business firms also have to cope with a large number of other
tensions like ideological conflicts, terrorism, traditional
hostilities, government interventions, labor activism and so on.
some of the components of political environment are:
Political system enables to:
• Determine and enforce rules, procedures for utilization and distribution of
resources.
• Integrates social, legal, economic and religious norms
• Makes executive policy decisions—national security, rights, duties and
privileges of citizens
Political system assumes the responsibilities and roles of a country’s
government:
• Maintain peace and security
• Ensure stability
• Maintain international relationship
• Provide basic services to citizens to facilitate their welfare, happiness
through constructive policies, institutions and infrastructures.
 Major components of political system:
• Communism
• Dictatorship or Totalitarian
• Capitalism
• Socialism
• Monarchy
The following enlisted points have been briefly explained:
• Communism:
Karl Max and Friedrich Engels, authored communist manifesto (1848)
propounded by Vladimir Lenin and Joseph Stalin.
means of production go to one political party, government controls
major means of production and resources.
i.e. Hungary, Czechoslovakia, Poland, East Germany, China, North Korea,
Vietnam, Angola, Cambodia, Mozambique and Cuba operated under
communism.
• Dictatorship or Totalitarian:
individual or a group of persons takes over all political power and make
decisions.
One person or party rules over the citizen.
Fascism is an extreme form of nationalism that calls for supremacy of the state.
i.e. Mussolini of Italy, Hitler of Germany, Kim un of North Korea.
Secular belief control through military power i.e. Cuba, China.
• Capitalism:
all factors of production should be owned, operated and traded by private sector
for profit.
It was popularized by Karl Marx and Friedrich Engels in Das Kapital
(1867).
Features of capitalism:
private ownership of means of production,
market economy
government makes legal framework of business and physical infrastructure.
 It believes on free trade, privatization and abolition of subsidies and
government support.
investment, distribution, income, production, pricing and supply of goods,
commodities and services are determined by private decision.
government should invest in areas where private sector cannot enter i.e.
infrastructure, public services.
mixed economy; state intervene in market activity and provides many
services.
citizens have political and civil rights and freedom.
• Socialism
govt. control over basic means of production i.e. Greece, Germany, Spain.
capitalism and socialism blended with provisions of private and public sector
to work together.
• Monarchy
monarch is the head of the state and pass on heir after their demise i.e.
England, Belgium
monarch has final discretion
• Legal system:
It is the process that guides the interpretation and enforcement of
regulatory norms, laws, and procedures.
There are three major legal system in the world—Civil law, common
law and religious law.
Civil Law: it is roman originated and constitution based codified
system of law officially followed by France, the Netherlands,
Germany, Spain and Portugal.
Common law: it is jurisprudence based system and originated in
Britain and followed by former British colonies and the US.
Religious law refers to ethical and moral codes taught by religions.
i.e. include Christian canon law, Islamic sharia, Jewish halakha and
Hindu law.
Legal system guides and regulates business setting ups, operations,
transactions and other business practices.
• Regulates and governs the conduct and behaviors of individuals or
institutions in a society.
• Specifies their rights and obligations
• Gives the processes by which such rules are enforced and grievances are
redressed.
General principles and features of legal system
• Foundation:
historical background, culture, traditions, customs and political
forces are foundation of legal system.
these affect how the law is written, interpreted and adjudicated.
• Political ideology:
legal system and ideology is guided by political ideologies.
• Citizen’s rights:
provides rights, freedoms and protections to the individual and
companies.
• Society’s views:
it reflects the common views of wide-segments of a society.
• Modes and conducts:
clearly indicates the limit that an individual or institutions cannot
cross, so as to preserve the social order.
• Penalties:
makes provisions for penalties for the violation of the limits or
the legal system.
 Legal areas of managerial concerns
From the international business perspective legal areas of concerns
are grouped into two:
Strategic concerns
product safety/liability and national standards
Marketing related regulations
local content requirements
legal jurisdiction and arbitration
protection of intellectual property rights
antitrust laws or competition laws/restrictive business practice laws
Ownership laws
foreign exchange
environmental liability
technology and non-equity investment
taxation
international trade and investment agreements
Operational concerns
Business registration and establishment
Contract and contract enforcement
Financial flows regulations
Pricing and wages
Hiring and firing
Bribery and corruptions
Bankruptcy or closing down of a company
The aforementioned points have been briefly highlighted below:
1. Strategic concerns:
some of the regulations which affect the strategic concerns of a
company are:
Product safety, liability and national standard:
each country has its own law and regulations, relating to
product safety, product liability and national standard.
i.e. USA product liability and safety laws are very stringent.
Market related regulations:
market monitoring and regulation laws i.e. pricing,
distribution system, use of mass media, promotional
means for advertisement, traceability.
i.e. conservative societies prohibit women to appear in TV
in swimsuit.
 Local content requirements:
require companies to use at least 25% of domestic resources.
Fulfills criteria of ‘rule of origin’ (ROD) to receive preferential duty access to
their products into developed countries.
Legal jurisdiction and arbitration:
foreign investor should carefully enter the clauses relating to
litigation (process of taking legal action) and arbitration in it’s FDI agreement
with host government.
Protection of intellectual property rights:
many treaties and conventions facilitates protection of intellectual
property rights i.e. copyright, trademark, patents.
need to assess national and international rules and it’s effective
implementation.
Antitrust laws or competition laws or restrictive business practice laws:
enacted with objective of encouraging fair competition, controlling
restrictive business practices.
i.e. price fixing, monopoly, hoarding, creating artificial shortage,
antitrust laws, consumer protection laws and commission that
oversees effective implementation.
Ownership laws:
foreigners are forbidden to own property in form of land and
building, machinery etc.
entitled to own a company holding share up to 100percent

Foreign exchange:
limit on repatriation of profit and capital
allocate limited exchange for importation of machinery,
plants and raw materials.
Environmental liability:
careful disposal of hazardous chemicals in open atmosphere,
destruction of nature, air, soil, water.
liability add to the cost of production and marketing
 Technology and non-equity investment:
i.e. licensing, franchising, contract manufacturing, outsourcing
and management contract.
manager must access the effectiveness of enforcement of
technology transfer act of a country.
return on investment can be repatriated without legal hindrance.
Taxation:
taxation influences the long-term strategy of a foreign investment.
knowledge regarding double taxation treaty between home and
host country.
International trade and investment agreement:
host country’s diplomatic relation with home country add value to
foreign investors.
agreement related to double taxation, expropriation, dispute
settlement, bankruptcy give confidence to investors to take risks.
2. Operational concerns:
concerned with legal system and regulations in host country i.e.
setting up a business, reporting and renewals, financial flow
regulations, pricing and waged, hiring and firing, bribery and
corruptions, bankruptcy or closing down of business among others.
Business registration and establishment:
official registration with line agency, local admin.
registration with income tax and VAT authorities
opening of bank account, registration of company seal.
Contract and Contract enforcement:
necessary to understand the legal system related to
contract i.e. leasing, procurement of raw materials
effectiveness of contract enforcement system
 Financial flows regulations:
based on foreign exchange act and legal practices.
financial system regarding flow of funds for fixed capital,
working capital, loan from bank and financial
institutions.
Pricing and wages:
regulations on pricing of product and services
minimum wage regulations to ensure adequate payments
to farmers, workers for the services of labors.
Hiring and firing:
legal provisions on hiring are relaxed to that of firing
In Nepal, firing is more complex i.e. require document
evidence on laborer negligence, non-conduct or
non- loyalty, lengthy court procedures, issues of
notifications, arrangement of compensation.
Bribery and corruptions:
Anti corruption act and foreign corrupt practices act (USA)
corruption is rampant is poorer nations then in developed
Bankruptcy or closing down of a company:
complexity arises if foreign company having owners in
home country and assets in host country.
legal provisions relating to winding-up/bankruptcy are:
definition
procedures
liquidation law
liquidator
UK introduced bankruptcy law in 1732 and USA (1800)
Nepal, Insolvency Act 2006
 Actors in Political and Legal Systems

The most important actors in political and legal systems are:

• Government
• International organizations
• Regional economic blocs
• Special interest groups
• National and multinational companies.
The aforementioned points are briefly explained below:
• Government:
operates on all level through different bodies, agencies, and
officials having power and enforces laws.
policy decisions and directions impact on business
transactions.
• International organizations:
WTO, UN, IMF, WBG, have strong influence on International business
activities.
WBG is one of the world’s largest sources of funding and knowledge for
developing countries.
It’s five institutions namely:
International Bank for Reconstruction and Development (IBRD)
International Finance Corporation (IFC)
International Development Association (IDA)
Multilateral Investment Guarantee Agency (MIGA)
International Centre for Settlement of Investment Disputes (ICSID)
facilitates free and fair trade by providing administrative guidance,
governing frameworks, technical assistance, occasionally financial
support.
committed to reduce poverty, increasing shared prosperity, promoting
sustainable development.
• Regional economic blocs:
EU, NAFTA, ASEAN, SAARC, aims to move forward the economic and
political interests of their members.
EU has it’s own executive, legislative, security and bureaucratic
bodies.
• Special interest groups:
formed to serve shared interests or concern of particular countries,
communities, industries, health, culture, environment, or other
causes with objectives of seeking to influence public policy.
i.e. civil societies, cartel organization (OPEC), environmental
protection organization like, Andean-Amazon Working Group, bar
association, religious organizations, World Human Right Commission,
Amnesty International etc.
may affect the cost of doing business---pricing of products or
services.
• Multinational and National Companies:
plays crucial role in investment, production, exchange of goods,
services, transfer of technologies, currencies.
all other actors in political system either facilitate or impede the
operation of companies.
 Political Risks

“Lower the political risk higher chances of attracting domestic/foreign

investment.”
Political decision or changes in the policy decision may be harmful
to business organization.
i.e. confiscation of properties, economic measure, political
sanctions or embargoes, violence and terrorism, traditional
hostilities.
Some of the political risks are enlisted below:
• National security: Wars, revolution, coup etc:
assess the national and political security before setting up
business in foreign country.
calculate risk of losing properties or investment before selecting a
country
• Expropriation and state ownership or nationalization:
involves seizure of company’s property without giving compensation.
legal guarantee or not implementing the policy of expropriation of property.
• Investment guarantee and dispute settlements:
international regulatory provisions, legal bindings, institutional mechanisms to
protect FDI.
i.e. Multilateral Investment Guarantee Agency (MIGA)
International Centre for the Settlement of Investment Disputes
• Privatization:
privatization is the transfer of ownership and management of public assets to
private citizens.
IMF and WB were implementing privatization in more than 100 countries.
reasons for privatization:
effective use of available resources
efficiency in production of goods and services
prudential mgmt. decisions
risk taking capabilities and result oriented research and development
• Political sanctions and embargo:
embargo involves complete ban on all commercial activities between two
countries.
In sanction, country prohibits trade in certain types of goods
i.e. sanctions against the trade of specific products
sanctions on economic or political relations
• Economic and labour conditions:
economic risks that come out of political decisions have direct impact on business
activities i.e.,
increase in income tax on profit
control in allocation of foreign exchange
imposition of law requiring to use certain percentage of input produced
domestically
restriction or ban---on imported items
price control system---to support public welfare
labour union
• Activisms and movements—political, economic, social & environment:
intentional actions to introduce political changes, economic justice,
social changes and environmental healthiness.
Activisms can be done through two systems:
Protests i.e. boycotts, rallies, street marches, strikes,
statement to in public media, petition drive, pamphleteering.
Persuasion i.e. convincing people or government about culture,
religion, feminists, campaigning, cooperation manner,
understanding.
• Lobbying is also kind of persuasion activism:
movement to influence the government authority or legislators
objective of ‘lobbyist’ is to get regulatory provisions or government
decision in their favor.
lobbyist can be consultant, layer, trade association, corporation executive,
chamber of commerce, think-tank among others.
USA has Lobbying Disclosure Act since 1995. Professional lobbyist in
Baltic nations have to get registered under regulations passed by respective
parliaments.
• Violence and terrorism:
terrorism include killings and kidnapping of people, destructions
of property, violence and other illegal activities.
political: to overthrow a government or to release their
imprisoned members
Economic: demand ransom to run or operate terrorist group
Religious: to punish non-believers of terrorist’s religion.
Ethnic: traditional fight between the parties and communities
Cyber terrorism: attack to damage computer service system by
virus.
i.e. Al-Queda, Irish Republican Army, Hamas, Japanese Red Army,
• Hostilities:
traditional animosity or enmities between tribes, races, religions,
ideologies. i.e. Arab vs Israel, Indian vs Pakistanis, Hutus vs Tutis
 Planning to reduce political risks
Following measures can be taken to reduce the political risks:
Macro or long-term measures
• Creating positive attitude towards foreign investment
• Careful selection of entry strategy
• Technology transfer and management only
• Strong bilateral agreement
Micro or short term measures
• Negotiation to phase-out
• Political lobbying and bribery
 Macro or long-term measures:
macro or long-term measures are some of the pragmatic measures
to reduce the political risks in developing countries.
• Creating positive attitude towards foreign investment:
positive attitude towards FDI among leaders, bureaucrats,
public awareness about FDI contribution to socio-economic dev.
i.e. give additional employment
bring capital and transfer new technologies
utilize domestic resources
upgrade skills of locals
substitute imports and promote export resulting favorable
balance of payments.
pay taxes to government
FDI have contributed to the economic and social wellbeing of
citizens of developing countries.
• Careful selection of entry strategy:
reduce risk by careful selection of entry strategy
joint venture strategy could be safer than full ownership in case of transfer of
capital in cash and machinery.
non-equity based investment i.e. providing license only to produce
or, franchising i.e. local use popular brand names
• Technology transfer and management only:
reduce risk by organizing transfer of technology and management
IFC and WBG facilitate in providing financial facilities
risk of confiscation and expropriation is minimal due to involvement of local
and international banks in investment abroad
• Insurance of investment:
insured with any insurance company or int’l financial corporation
MIGA provides information on investment opportunities, guarantee to FDI.
International Centre for Settlement of Investment Disputes (ICSID) facilitates
settlement by conciliation or arbitration of FDI disputes.
• Strong bilateral agreement:
urging host government to enter into bilateral investment
agreement with home government.
mentioning strong clauses to compensate fully in case of
expropriation of a assets of foreigners
Micro or short term measures
• Negotiation to phase-out:
negotiate with government for planned phasing out and
compensation.
• Political lobbying and bribery:
bribe political parties/leaders to escape from confiscation or
expropriation.
 Government Interventions and Trade and
Investment Barriers
• Trade barriers were introduced by modern states in 16th century to
promote national income, economic growth, standard of living.
• Government intervenes and differentiates between domestic and foreign
trades and imposes restrictive regulatory measures on products, services
or capital.
• Measures are taken to satisfy economic, social and political goals
fiscal/tariffs measures i.e. import/export tariffs or duties
non fiscal measures i.e. quotas, quantitative restrictions, licensing,
technical barriers to trade, pre-shipment inspection, documentary
requirements, government procurements, intellectual property,
subsidies etc.
 Strategic policy objective of government intervention are:
• Monitor imports
• Boost national export
• Promote domestic and foreign investment
• Consider national security, national economy, health of people, plant,
animal and environment
• Monitor technical standards of products and services
• Keep external economic relations strong and stable
WTO, GATT has set standard provisions of barriers i.e. safeguard,
balance of payment measures, technical barriers to trade,
 Government’s intervention and general policy objective
Some of the government’s intervention and general policy objective of or
promotional measures are discussed below:
• Revenue generation
• Protection of domestic production and increase in employment
• Protection of live and health of human, animal and plant
• Maintain technical standards
• Balance of payment
• Discourage unfair competition and conspicuous and luxurious
consumption
• Promotion of exports
• Religion and defense
• Industrialization arguments
 Aforementioned points have been briefly explained below:
• Revenue generation:
custom tariffs contributes more than 20 percent to total
government revenue.
tariff brings inflation, reduces the trade volume, decreases
consumption.
luxurious, non-essential items are subject o high tariff in Nepal.
• Protection of Domestic production and Increase in Employment:
tariff provides protection to domestic infant industries.
provide guarantee major share of domestic market until can
compete with imports.
imposing ‘safeguard’ measures called ‘Escape clause’ to provide
relief to domestic industry.
• Protection of Live and Health of Human, Animal and Plant:
protect human and animal life and health from:
additives, contaminants, toxins or disease-causing organisms in foods,
beverages.
risk arising from the entry, establishment or spread of pests, diseases,
disease-causing organisms.
risk arising from diseases carried by animal, plants or their products.
must be based on scientific principles
no discrimination between members with similar or identical conditions.
• Maintain technical standards:
standards create barriers and distort trade.
standards include terminology, features, (size, quality, colour, quality,
components, grading, symbols)
mandatory technical regulations to protect life, health of human, animal,
plant, environment and prevent deceptive practices and facilitate product utilization.
• Balance of payment:
developing countries suffer from low inflow and little reserves of foreign
currency
measures i.e. import surcharges, increase in tariffs, quantitative restriction
on import volume among others.
• Discourage unfair competition and conspicuous and luxurious consumption:
impose anti-dumping duties and countervailing duties to discourage
foreign companies from dumping goods
impose tariffs and non-tariff barriers to control and discourage use of
luxurious items i.e. alcohols, cosmetics, jewellery, fashion ware, artistic products
etc.
• Religion and defense:
import of certain products are banned for defense and religious reasons.
• Industrialization arguments:
protection supports increase in FDI and diversification of economy.
 Tariff and non-tariff barriers in Trade

“Trade policy measures or instruments are broadly grouped into two:

Tariff measures (TMs)
Non-tariff measures (NTMs)
• Tariff measures:
basic instruments of trade policy.
tariffs are taxes or duties imposed on products when they cross
nation’s border.
custom tariffs are calculated on three bases:
Ad valorem (based on value):
Value (based on quantity)
Combined or mixed (based on value and quantity)
• Non-tariff measure (NTMs):
it is policy measure rather than ordinary customs tariffs.
it is normally imposed on trade, customs, foreign exchange, finance, intellectual
property, food, plant, animal, health and environment related acts, regulations, or rules.
Non-tariff measure include:
Sanitary and phyto-sanitary
technical barriers to trade
pre-shipment inspection
contingent trade protective measures
non-automatic licensing, quota, prohibition, quantity control.
Price control
finance measures
measures affecting competition
Trade related investment measures
subsidies, government procurement, intellectual property
rules of origin, export related measures
Some of the provisions of technical non-tariff measures under WTO are
discussed below:
• Agreement on the application of sanitary and phytosanitary measures:
deals with food safety, animal and plant health regulations.
to protect human, animal, plant life, diseases that may be brought
in by imported agricultural and forestry products.
• Agreement on technical barriers to trade:
meet national regulations to protect human health, preserve
environment and natural resources.
different standard may create unnecessary barriers
 Cultural environment—concept and
importance
A ‘society’ is built by a particular group of human being and ‘culture’ is
a ‘way of living’ or ‘unique lifestyle’ of a society.
• It includes social institutions i.e. family, educational, religious, kinship
and extended family, governmental and business.
• A culture is a sum of lifestyle, value, attitudes, beliefs, rules of
conduct and behavior, techniques, aesthetics, artefacts.
• Int’l market is influenced by prevailing social and cultural forces i.e.
corporate behavior, plans and strategies in foreign market.
• Each socio-cultural norm has its own logic or sensible reason.
“knowing the customers and people require understanding of
history, societal norms and cultural values”
• Understanding of culture, people helps to effective interaction with
foreign clients and colleagues.
In order to understand the socio-cultural value of people, Prof Donald A Ball has advised to
follow “Six Rules of Thumb”
• Be prepared:
researching about country’s history, socio-cultural values, political and economic
structure, business practices.
• Slow down:
don’t rush let the foreigner also understand you.
• Establish trust:
takes time to build trust and long term relationship even having competitive offer in
terms of quality, price and terms.
• Understand the importance of language:
better to hire a local professional interpreter despite understanding the foreign
language.
• Respect the culture:
respecting host’s country social, cultural norms and rules is crucial.
• Understand the components of culture:
Surface culture: food, life-style, education, language, material culture.
Deep culture: attitude, beliefs, religions, aesthetic values, kinships etc.
 Why culture matters in International Business?

“Culturally adopted business can lead to best performance with innovative ideas and
techniques”
Culture matters in international business for following reasons:
• There is no universal culture
• Changing socio-cultural environment
• Adaptation and standardization
• Areas of cultural universe
• Cultural empathy
• Power distance
• High-and low-context cultures
• Low context culture
• Communication and negotiation
• Social behaviors
• Intercultural socialization
The aforementioned points have been briefly highlighted below:
• There is no universal culture:
wide acceptance of food, drinks, luxury items doesn’t mean total
globalization.
managers should never ignore the cultural forces of a particular
country and business plan and strategies.
approaches have to be different depending on a country’s socio-
cultural norms.
• Changing socio-cultural environment:
with the advent of globalization socio-cultural environments are
changing.
changes affect social life, perception, consumer behaviors,
consumption patterns and market segment.
flexible, inter-cultural relationships to helps to manage cross-
cultural differences.
• Adaptation and standardization:
make prudent decision where cultural universal are possible and
adaptation are required.
MNCs have standardized products which are universally accepted.
• Areas of cultural universe:
i.e. music, dances, sports, entertainment, education, travel, finance
services, electronic equipment are universal.
spreading worldwide and accepted by many countries.
• Cultural empathy:
the ‘way of thinking’, ‘way of living’ are different in assorted
geographical regions.
helps to understand things move with your integrity to work and
generosity toward host country’s way of life.
manager have to be empathetic and get along with local people
adjust to determine business strategies accordingly
• Power distance:
every society has a phenomenon of power distance.
i.e. individualism vs collectivism, masculinity vs femininity, employers vs
employees, developed country vs rich country.
• High-and low- context cultures:
Edward T Hall defined the concept of high-and low-context as understanding
different cultures.
In high context culture: person’s word is his bond.
less legal paper work, lawyers are less important and emphasis is given on
person’s social status, position and values
i.e. Japan, India, Middle-East, China,
sense of fair play and widespread acceptance of rule of the game.
Low context cultures:
contract, through legal writing and signed paper is required,
lawyers are important.
no importance attached to person’s background, values and
relationships, i.e. USA, Western European countries.
• Communication and negotiation:
concern social and cultural norms in using promotional means including advertisement.
use of non-verbal communication i.e. kinesics, appearance, posture, eye contact,
paralanguage, symbolism etc.
i.e. bowing half of the body, handshakes,
• Social behavior:
both hands are used in presenting visiting card in China,
Namaste is used to greet visitors in south east Asian countries.
foreigners are not supposed to ask anything about spouse in middle east and Pakistan
• Intercultural socialization:
different countries have various behaviors, habits, actions and logic behind it.
i.e. different bath tops are used in Britain, France, Japan for hygienic reason
European use toilet paper, Indian use water and normal in Chinese culture to use nothing.
managers are supposed to accept such ways of life and abide by social norms in foreign
countries.
 Regional economic integration-types and
leading economic blocs
‘Regional economic integration refers to efforts to promote free and fair
trade on a regional basis.’
In another word, Economic integration or regional integration, is an
agreement among nations to reduce or eliminate trade barriers and agree
on fiscal policies.
i.e. agriculture, tourism, investment, financial and banking
services, exchange of technologies, research, culture among others.
It is process in which two or more countries form a group to eliminate
economic barriers, with the end goal of
enhancing productivity
achieving greater economic interdependence.'
In summary,
An agreement between groups of countries in a geographic region to
reduce and ultimately remove tariff and non-tariff barriers to the free flow
of goods, services, and factors of production between each other.
Advantages of REI
• Trade creation
• employment opportunity
• consensus and cooperation between member states
Disadvantages of REI
• Trade diversion
• employment shifts and reductions
• loss of national sovereignty
• rising crime rate
 Stages and features of regional economic integration

‘The WTO under the exception to non-discrimination or MFN clause has

made provision to permit formation of regional blocs.’
• Member states are required to notify WTO of their involvement in
regional trade and investment agreement.
Stages of regional economic integration
• Free Trade Area (FTA)
• Customs Union (CU)
• Common Market (CM)
• Economic Union (EU)
The stages are briefly explained below:
Figure: Stages of REI
Level 1: Free Trade Area (FTA)
• All barriers to the trade of goods and services among member countries
are removed.
• Each country is allowed to determine its own trade policies regarding non-
members.
• Accounting for almost 90% of regional agreements.
Examples of FTA are:
SAFTA (Afghanistan, Bangladesh, Bhutan, India, Nepal, Maldives, Pakistan
and Sri Lanka)
EFTA (Iceland, Liechtenstein, Norway, Switzerland----1960)
NAFTA (Canada, Mexico, the US---1994)
BIMSTEC (Bangladesh, Bhutan, India, Myanmar, Nepal and Thailand)
Level 2: Custom Union (CU):
• Eliminates trade barriers between member countries and adopts a common
external trade policy.
• Members agree to impose harmonized or common tariffs on all imports from
non-member countries.
• Imported goods from non-member countries can move freely between the
territories of member countries are tariffs are imposed in one of the member
countries.
• Most countries that enter into a customs union desire even greater economic
integration down the road.
• Initially EU had entered into customs union and later went on the develop EU.
• Examples of Customs Union are Andean community that existed among Bolivia,
Colombia, Ecuador, and Peru.
Level 3: Common Market
• No barriers to trade between member countries, It includes a common
external trade policy. It allows factors of production to move freely between
members.
• There is no restrictions on immigration, emigration, or cross-border flows of
capital between member countries.
• Establishing common market demands a significant degree of harmony and
cooperation between the member states.
• Examples of common market are:
Mercosur---Argentina, Brazil, Paraguay, Uruguay, Bolivia and Chile
Gulf Cooperation Council---Bahrain, Kuwait, Oman, Qatar, Saudi
Arabia, United Arab Emirates.
Southern African Customs Unions (SACU)-----Botswana, Namibia,
Lesotho, South Africa and Swaziland.
Andean Community (CAN)----Bolivia, Colombia, Ecuador, Peru,
Venezuela.
Level 4: Economic Union
• A common currency
• harmonization of members' tax rates
• a common monetary and fiscal policy
• demands not only a coordinating bureaucracy but also the sacrifice of
significant amounts of national sovereignty to that bureaucracy.
• In Economic Union, all the fiscal and monetary policies of the member
countries are unified to create even greater economic harmonization.
• Example of Economic Union is the European Union (EU) has unified
politically as it has
i). a single market concept,
ii). single currency, Euro, monitored by European Central Bank
iii). single European parliament, single combined European army.
 Conditions of Economic Integration

‘The REI has trade, investment, employment, income benefits and political
advantages in term of reduction in conflicts and increased cooperation.’
The main objective of REI include trade and investment relations for
achieving economic goals.
Following conditions need to be considered in order to maximize benefits of
REI.
• Economic status
• Unconditional movements of goods, services and resources
• Common market
• Harmonized fiscal and monetary policies
• Short distance
• Common socio-culture
 Leading economic blocs
Some of the leading economic blocs in the world are as follows.
• European Union (EU)
• North American Free Trade Agreement (NAFTA)
• ASEAN Free Trade Area (AFTA)
• South Asian Free Trade (SAFTA) of SAARC
• The BIMSTEC Free Trade Area

A aforementioned economic blocs have been explained below:

• European Union (EU)
integration of Europe was proposed by French Foreign Minister Robert
Schuman in 9 May, 1950.
earlier, known as European Economic Community (EEC)
began as a Custom Union (CU)
regional institution of 27 members committed to integrate their economic
and political cooperation.
1).European Union:
single market of 4.3 million square kilometers and population of 500
million
Per Capita GDP was US$ 41, 504,
Total GDP (Nominal) was US$ 17.1 Trillion.
accounts for more than 32 per cent of world merchandise trade and
40 per cent of world trade in commercial services.
rule of law is fundamental to EU.
All EU decisions and procedures are based on the Treaties, which are
agreed by EU countries.
All the member states are subject to obligations and privileges,
common legislative and judicial institutions.
First European regional cooperation had began in 1948, with the
formation of Benelux Union (Belgium, Netherlands, Luxembourg)
 Treaties and Membership
• In 1957, six countries including Belgium, France, West Germany, Italy,
Luxembourg, the Netherlands signed two treaties:
European Economic Community (EEC)
European Atomic Energy Community (EAEC)
• 1973, the UK along with Ireland and Denmark joined EU taking the count to
nine.
• In 2004, the biggest enlargement took place when Cyprus, the Czech
Republic, Estonia, Hungry, Latvia, Lithuania, Malta, Poland, Slovakia, and
Slovenia joined EU.
• In 2007, Bulgaria, Romania and Croatia join EU in 2013.
• Countries interested to join EU are: Turkey, Macedonia.
Schengen agreement took place in 1985 and 1990, rules apply among most
European countries.
Rules include common policy on temporary entry of persons, harmonization of
external border control, cross border police and judicial cooperation.
 Purposes of the EU
• Working together for peace and prosperity, “Unity in Diversity”
• Delegating a certain amount of their sovereignty to the EU, so decisions on specific matters of common
interest can be made democratically.
This pooling of sovereignty is called ‘European Integration’
• Implementing legislation and adjudication at the European Court of Justice.
• Achieving four fundamental freedoms:
Freedom of movement of goods, services, capital and people
EU is organized with five institutions:
The European Parliament (EP)
The Council of the EU
The European Commission
The European Court of Justice and
Court of Auditors (COA)
They are supported by five different bodies:
European Economic and Social Committee
The committee of the regions
The European central Bank
European Ombudsman
European Investment Bank
 EU progress to-date:
• Deals with many other subjects of direct importance of everyday life i.e. citizens’
rights and freedom, security and justice, job creation, regional development,
environmental protection and making globalization work.
• Stability and prosperity i.e. raise living standards, Europe-wide single market,
area of freedom security and justice, joint efforts to tackle problems of terrorism,
drug and human trafficking.
• Single currency system, the Euro and strengthened Europe’s voice in the world,
eliminated currency exchange fees.
• Harmonized more than 100,000 national standards, labelling laws, testing
procedures and consumer protection measures.
• EU as a single market has created more jobs and boosted overall economic
development of Europe.
• Efforts for single research and development (R&D) initiatives, innovation and
technological development—to achieve mutual socio-economic goals
• Caring environment as more than 200 directives for environmental protection
are made.
 Cross-cutting issues of EU
Some of the critical issues relating to the development of European Union
are:
• Erosion of sovereign power of the member states
• States having different level of economic growth and interested to join EU
wagon
• Many economically less developed nations have losses of traditional
customs revenue and export subsidies among others.
2). North American Free Trade Agreement (NAFTA):
NAFTA, one of the largest trade bloc, was formed in 1 January 1994.
A trilateral agreement was signed between Canada, USA and Mexico. It’s
main objective is to strengthen the economics of the member countries.
It is the only trade agreement to facilitate trade within the area.
member countries are committed to promote free trade among them
In September 2018, the US, Mexico and Canada reached an agreement
to replace NAFTA with US-Mexico-Canada agreement (USMCA), pending it’s
ratification.
For more than two decades now, it has witnessed profound economic
change among the member states.
Taking advantage of free movements of goods, many production facilities
were relocated from one country to another.
Despite the US failure to enlarge NAFTA and mitigate the negative effects
of resources shifts and production relocation, it remains important for
American business.
3). ASEAN Free Trade Area (AFTA)
The Association of Southeast Asian Nations was established in
August 8, 1967 in Bangkok.
It is a regional intergovernmental organization comprising ten
countries in Southeast Asia.
promote intergovernmental cooperation
facilitates economic, political, security, military,
educational and sociocultural integration.
the agreement of AFTA was signed on 28th January 1992 in S’pore.
The objective of AFTA are:
increase ASEAN’s competitive advantage
eliminate trade barriers within ASEAN
to attract more FDI
The main instruments to achieve the objectives of ASEAN are as follows:
• The common effective preferential tariffs (CEPT) scheme:
temporary exclusions—delying in tariffs reduction (0-5)
no tariff reduction in sensitive agricultural products
general exceptions i.e. protection of national security, public morals,
human, animal, plant life and health.
• Rule of origin:
must use 40 per cent of local resources,
exporter must complete form D, certificate of ASEAN origin to be
attested by the designated authority.
• Organization involved:
ASEAN secretariat, ASEAN national customs and Trade departments
are the authorities to handle and implement AFTA.
ASEAN protocol on Enhanced Dispute Settlement Mechanism
governs formal dispute resolution.
 Some of the cooperation efforts of ASEAN are:
• ASEAN plus three: ASEAN plus China, Japan, South Korea—to support
Asian financial crisis
East Asian Summit
Chiang Mai Initiatives for financial stability
• Asian Development Bank: for Mekong River Project, and
• AANZFTA: ASEAN—Australia—New Zealand Free Trade Area (27 February
2009)
 South Asian Free Trade Area (SAFTA) of SAARC

Objectives of SAARC:
• To promote welfare and improve quality of life of South Asia.
• To accelerate economic growth, social progress and cultural
development in the region.
• To promote and strengthen collective self reliance among the countries
of South Asia.
• To promote active collaboration and mutual assistance in the economic,
social, cultural, technical and scientific fields.
• To strengthen cooperation with developing countries.
• To cooperate with international and regional organisations with similar
aims.
 Formation of SAFTA
• In 1993, the Agreement on SAARC Preferential Trading Arrangement
(SAPTA) was formed to promote collaborative efforts in trade sector.
• ‘preferential tariffs’ and limited coverage of goods, could not prove
instrumental in promoting mutual trades and economic cooperation
• Realization of importance of regional economic integration, SAARC
members set up SAFTA
to harness the benefits of ‘free flow of goods’
for optimum utilization of resources
develop respective national economies.
• Since January 1, 2006, SAFTA has been playing significant role in
developing the regional economic integration in South Asia region.
 Objectives of SAFTA
• Eliminate barriers to trade, facilitate in cross-border movement of goods
between member countries.
• Promoting condition of fair competition in free trade area
• Ensuring equitable benefits to all contracting states
• Creating effective mechanism for the implementation and application of this
agreement, for its joint administration and for the resolution of disputes.
• Establishing framework for further regional cooperation to expand and
enhance the mutual benefits of this agreement
Principles of SAFTA
• It is governed by the provisions of the Agreement, rules, regulations,
decisions, understandings and protocols.
• Contracting states affirm their existing rights, obligations with respect to
each other under Marrakesh Agreement Establishing the WTO and other
treaties.
• SATFA is based and applied on the principles of overall reciprocity and mutuality
of advantages.
• It involves the free movement of goods, between countries through, inter alia, the
elimination of tariffs, para-tariffs (border charges and fees) and non-tariff (quota)
restrictions on movement of goods.
• It entails adaptation of trade facilitation and other measures, progressive
harmonization of legislations by contracting states
• Special need of least developed contracting states are clearly recognized by
adopting concrete preferential measures
• SAFTA does not preclude any member states from receiving and giving tariff
preferences under the existing bilateral agreements.
Instruments: Major instruments of the SAFTA are:
• Trade liberalization program:
bring down the tariff to 0 to 5 per cent within 7 years except Sri Lanka (8
yrs) and period of 10 years by least developed states.
incorporates the provision for negative list (sensitive list) of goods not
entitled for tariff reduction.
 Instruments of SAFTA:
• Institutional arrangements:
SAFTA Ministerial Council (SMC) is the highest decision-making
body, responsible for administration and implementation of this
agreement.
SMC consists of Ministers of Commerce/Trade of the respective
states, meets once a year.
It is supported by Committee of Experts (COE)
COE monitors, reviews, facilitates implementation of the SAFTA
provisions and undertakes tasks assigned to it.
COE also acts as Dispute Settlement Body under the SAFTA
Agreement.
COE meets at least once every six months.
• Rules of origin:
The Rules of Origin of Goods under the Agreement on SAFTA, has 17
Rules and 21 Articles.
Origin of products in the member countries are determined by:
Wholly produced or obtained in the territory of exporting
contracting states.
Not wholly produced/obtained but sufficiently worked or
processed in the territory of the exporting contracting state
provided that the said product fulfill the specified condition.
i) either final product is classified in a heading at four
digit level of HS differently from those of imported
materials used.
ii) use of input originated in foreign states does not
exceed 60 per cent of FOB value of product and final
processing is exporting state.
 Advantages of SAFTA
• Market enlargement:
all contracting states will be able to share benefits of expanded
market.
• Investment:
FDI will be attracted in the expanded market to achieve the
economies of scale.
• Growth of Trade:
specialization in items having comparative cost advantage will lead
to new trade creation in various goods.
• Cooperation in sectors i.e. energy, electricity:
possibility of developing a system for interdependence on energy
sources through regional cooperation.
 Challenges to SAFTA
• Great deal of political tension exists between arch-rival India and
Pakistan
• SAFTA negotiators are facing difficulties in ensuring that the
agreement is compatible with the relevant provisions of the WTO.
• SAFTA becomes trade creating mechanism instead of trade diverting
one.
• SAFTA is finding difficulty in ensuring the interests of the business
communities and government of least developed countries, who do not
want to lose their identity by mixing with big economies.
 The BIMSTEC Free Trade Area
• The BIMSTEC, established as a regional economic bloc in June 1997 to
strengthen socio-economic cooperation.
(Bangladesh, India, Sri Lanka, Thailand, Myanmar, Bhutan and
Nepal in Feb 2004)
• Core area of Bay of Bengal Initiative for Multi-sectoral Technical and
Economic Cooperation, i.e. agriculture, energy, fisheries, tourism, trade
and transportation.
• Agreement on BIMST-EC Free Trade Area (FTA) was signed and came
into effect since July, 2006.
The main objective of FTA of BIMST-EC is to strengthen and
enhance economic, trade and investment cooperation.
exploration of new areas, develop appropriate measure for closer
cooperation among parties, facilitate economic cooperation.
 Instruments to achieve the objectives are:
• Elimination of trade barriers:
i.e. trade liberation, rules of origin (40 % value addition), treatment of
out-of-quota rates (Out-of-quota rate does not set any limit on quantity but
applies normally higher tariff rate) non-tariff barriers, safeguard measures etc.
• Liberalization of trade:
in service with substantial sectoral coverage.
• Open, facilitate and promote treatment
flexibility to the LDCs.
• Expansion of economic cooperation:
i.e. technology, transportation, energy, tourism, fisheries.
• Establish appropriate mechanism
for implementation of the agreement i.e. trade and investment
facilitate measure i.e. simplification of customs procedures, customs
cooperation, standards and technical regulations, trade finance, e-
commerce, business visa and travel.
• BIMST-EC FTA—wide scope agreement covering trade-in-service and
investment including tourism apart from trade-in-goods (extent of import
and export)
aims at elimination of trade barriers,.
members have agreed not to include more than 1300 items in
negative list
approve to identify products of fast track under trade
liberalization program.
 Emerging foreign market

‘new industrialized countries are considered emerging economies that are yet to
reach developed status.’
high participation in international stock exchange market, international
trade, finance.
have population below poverty level with huge gaps in income
distribution.
Some of the features of emerging foreign market are as follows:
• Per capita income of these countries is high
• Economic growth rate is high
• Expediting liberalized economic system with policy and institutional
transformations.
• Expanding middle class, improving living standards,Social stability and tolerance
• Increase in regional and multilateral institutions.
(Argentina, Brazil, China, India, Indonesia, Mexico, Poland, South Africa, South
Korea, Turkey) others Egypt, Iran, Nigeria, Pakistan, Russia,
 Changing demographics of global
economy
• Defensive monopoly capitalist era began with the introduction of MNCs,
international institutions i.e. UN, WB, IMF, GATT/WTO. (General agreement on
tariffs and trade)
• Gradual changes in market, demography, income, employment, consumption, mass
production, new technologies, digital, bio-chemistry, innovations, renewal energy,
green chemistry, regional integrations, new institutions and ICT.
• Introduction of modern and dynamic practices
innovative, dynamic, prudent (care) leadership----research and innovation.
information and communication technology (ICT)
evolution of multinational companies
Gradual economic globalization with liberalized economic policies for
conducive business environment
availability of international business finance
economic integration---international, regional institutions and conventions
 The changing demographics of global economy can be classified into five
important trends:
Change in world output—GDP
Change in World trade
Change in world foreign direct investment
change in multinational enterprises
change in institutional and other aspects
A aforementioned points have been briefly explained below:
• Change in world output—GDP:
World GDP in US$ increased by over 6200 per cent from 1.27 trillion in
1960 to 80.7 trillion in 2017.
World GDP was distributed by:
63.8 per cent to high income economies
27.5 per cent to middle upper income economies
8.2 per cent to middle lower income economies
0.7 per cent to low income economies
• Change in world trade:
In the past 70 years, average of export and import grew dramatically
from US$ 60 billion to US$ 17.87 trillion
USA total export decreased from 21.7 per cent to 9 per cent.
USA is the highest importing and second largest exporting country.
Western European countries decreased their import from 45 per cent
from 1948 to 37 per cent in 2017.
China, Japan, South Korea trade grew from 14 per cent in 1948 to 34 per
cent in 2017.
China is a leading exporter with around 13.2 per cent of world market.
• Change in multinational enterprises (MNEs):
British East India Company is regarded as the world’s first MNEs
MNEs in 17th century focused on expansion of territories and use of
resources for company’s benefits.
Rapid growth in modern MNEs, facilitated by advent of ICT and
liberalization of world economy.
• Change in Multinational enterprises (MNEs)
estimated 7000 MNEs in 1970s
not less than 230,000 MNEs in the world now
conflict of interest exists between the MNEs and the host government
MNEs are attracted due to following reasons:
availability of resources i.e. land, labor, capital
growing market
availability of institutional finance
comparatively flexible taxation
countries interest in attracting MNEs
support economic growth with value chain development
employment generation
bring new investment
introduce new technology
• Change in institutional and other aspects:
Many leaning institutions i.e. UN, WB, IMF, Organization for Economic
Co- operation and Development (OECD), WTO,
United Nations Conference on Trade and Development (UNCTAD)
Organization of the Petroleum Exporting Countries (OPEC), ADB
At regional level EU, SAARC, SAFTA, NAFTA, ASEAN, Economic
Community of West African States (ECOWAS)
Former communist nations in Europe and Asia committed to democratic
politics and free market economies.
UN has classified 17 nations including countries under Soviet Blocs as
countries in transition.
formation of BRICS (prevented them to declare as developed nations)
Socialists, environmentalists have taken steps to reduce negative impact
of globalization.
regional economic integration is being recognized and gaining
momentum.
 International monetary and financial environment

“Monetary policy is the management of money supply, price, interest

rate, foreign exchange to achieve macroeconomic stability in the areas
i.e.
inflation, consumption, growth and liquidity.
It is supervised and monitored by the Central Bank with related acts and
regulations in close association with the Finance Ministry or Treasury
Ministry of the country.
In general monetary instruments are:
Money supply (circulation and credit)
cost of money (interest)
General price (inflation)
Foreign exchange
 The objectives of monetary policy are:
• Price and economic stability by monitoring inflationary pressure, liquidity,
consumption growth, and economic deflation (decline in price of goods
and service or contraction in the supply of money and credit in the
economy)
• Full employment
• Foreign exchange stability

Some of the important areas that need to be considered by an

International business manager are as follows:
Money supply
Inflation
Credit availability and interest rates
Foreign exchange
These enlisted points are briefly highlighted below:
• Money supply:
money is defined as anything that is generally acceptable as a
means of exchange.
supply of money (M) is the total currency in circulation (C) plus the
demand deposit with the commercial banks (D) or M=C+D
Change is money supply has equiproportional relation with the
change in price level and inverse relation with the exchange value
(purchasing power) of the money.
i.e. price level increases or decreases at the same time with
increase/decrease in money supply and
purchasing power of money decrease with increase in money
supply and vice-versa.
data available in the annual and periodical reports of the Ministry
of Finance and Central Bank of the country.
• Credit availability and Interest rate:
assess the credit availability and cost of such credit (interest)
situations of the host country.
data are available in annual and periodical reports of Ministry of
Finance and Central Bank of respective country.
• Foreign exchange:
minimize the holding of weaker currencies, and try to maintain the
cost of production and cost of capital as low as possible.
• Inflation:
increase in prices and fall in the purchasing value of money.
It is measured by the consumer price index (CPI).
Inflations of various nations are presented by IMF, World Economic
Outlooks.
It is one of the external forces completely uncontrollable to a business firm
and it directly impact on the business transactions in different forms.
Inflation makes expenditure plan more risky
i.e. if the price increases more than estimate, it may
result in loss/reduce profit
inflation rate determines the cost of borrowing
if the inflation is high, cost of capital increase and
reduction in profit.
inflation encourages borrowing and discourages lending
when money value remain low, business person try to
borrow money and investment on something.
Inflation increases interest rate, encourage export but
discourage import.
 Currencies and exchange rate system

“Foreign exchange is a payment mechanism for international

transactions.”
• Foreign exchange rate is the number of unit of one currency needed to
buy one unit of the other currency, based on purchasing power parity.
Payment for foreign transactions involve foreign exchange for following
reasons:
there is no common money acceptable to all countries.
almost all countries depend on foreign transactions as none of
them are self-sufficient.
globalization has enlarged social, economic and political
relationship between nations.
“Foreign exchange, as a system of conversion of a national currency into
other foreign currencies or an exchange of one money for another.”
• Foreign exchange also enable conversions, calculations and comparisons
of costs and prices of goods and services being traded internationally.

Fluctuation in currency values:

• Some of the important currencies floating in the international markets
are; US Dollars, EU Euros, British Pounds, Japanese Yens, Canadian
Dollars, Swiss Francs, Australian Dollars, Chinese Yuan and Swedish
Krona.

fluctuation in currency values results in:

reduce the profit margin to the extent of loss resulted from
the difference in exchange rate.
increase the price of goods in the local market.
 Reasons for fluctuation in currency value
• In the long-run, factors determining the fluctuation in currency value are:
Political
Macro-economic i.e. economic outputs, unemployment, inflation
Fiscal i.e. tax cuts, increased government spending
Monetary environmental forces
• In the short and med-term, specific forces lead to fluctuations of the value of a
currency
per capita gross national income (GNI) i.e. income earned by people
and businesses
Money supply and money demand
interest rates
production, productivity and employment
inflation rates i.e. 5.97 per cent
Balance of payment (BoPs)
Speculations of market players.
 Speculations of market players:
• Increase in money supply will result in a decrease in currency’s value and
vice-versa.
• Increase in nominal interest rate (before inflation rate) will decrease in
currency’s value.
• Increase in real interest rate will increase in currency’s value.
• Increase in production, productivity and employment increase in currency’s
value.
• Increase in inflation rate means decrease in currency’s value as purchasing
power parity (PPP) of currency also decreases.
• Favorable BOPs situation will result in an increase in the value of domestic
currency.
• Increase in per capita GNI---will result in an increase in currency’s value as
there will be greater demand for currency.
“A manager’s prudent decisions are frequently needed to foresee, minimize
and avoid losses that might result from fluctuation of currency value.”
 The Floating Exchange Rate System

• Foreign exchange rate is determined by the market conditions of demand

for and supply for foreign exchange.
• A floating exchange rate refers to an exchange rate system where a
country's currency price is determined by the relative supply and demand of
other currencies.
• A floating rate occurs when governments allow the exchange rate to be
determined by market forces and there is no attempt to influence the
exchange.
Advantages of floating exchange rate system
• It is simple to operate as exchange rate moves automatically
• Helps promotion of foreign trades
However, frequent changes in rates cause uncertainty in business and
investment,
risk taking capability of entrepreneurs are reduced
 Modes of Payment in International Trade
“Any sale is a gift until payment is received and therefore exporters
wishes to get payment as soon as possible.”
• Traders must offer their customer attractive sales terms supported by
appropriate payment methods to succeed in the global marketplace
and win sales against foreign competitors.
• For international trade ranked in order from most secure for the
exporter to least secure, the basic methods of payment are:
Cash in advance (CIA)
Letter of credit (L/C)
Documentary collection (DC) or draft
Open account (OA), and
Other payment mechanisms i.e. consignment sales
A aforementioned points have been briefly explained below:
• Cash-in-advance (CIA)
Cash in advance is a payment term used in some trade agreements.
With cash-in-advance payment terms the buyer makes payment first and waits for
the seller to forwards the goods.
It requires that a buyer pay the seller in cash before a shipment is received and
oftentimes before a shipment is even made.
• Letter of Credit (L/C)
It is one of the most secure instruments available to international traders.
An L/C is a commitment by a bank on behalf of the buyer that payment will be
made to the exporter.
A letter of credit is a document that guarantees the buyer's payment to the
sellers.
In other words, L/C is essentially a financial contract between a bank, a bank's
customer and a beneficiary.
A L/C, also known as a documentary credit, or bankers commercial credit, or
letter of undertaking (LoU), is a payment mechanism used in international trade to provide
an economic guarantee from a creditworthy bank to an exporter of goods.
• Documentary collection (DC)
It is a method of trade finance in which an exporter's bank forwards
documents to an importer's bank and collects payment for shipped
goods.
It is a process in which seller instructs their bank to forward
documents related to the export of goods to a buyer's bank with a request
to present these documents to the buyer for payment.
Documentary collection is a procedure that allows a seller to give
their bank instructions to forward trade-related documents to the bank of
a buyer.
In a Documentary Collections transaction, the exporter's and the
importer's bank facilitate the export sale by exchanging shipping
documents for payment.
Figure: Documentary collections (DC)
• Open account (OA)
An open account transaction is a sale where the goods are shipped and
delivered before payment is due, which is usually in 30 to 90 days.
exporters offer competitive open account as they do not want to lose a sale to
their competitors.
use one or more of the appropriate trade finance techniques i.e. export credit
insurance.
It is one of the highest risk option for an exporter.
• Consignment
It is very risky, exporters is not guaranteed any payment as goods are with
independent agents in foreign country.
It is a variation of open account in which payment is sent to the exporter only after
goods have been sold by foreign distributor.
However, it helps exporters become more competitive on the basis of better
availability and faster delivery of goods.
Helps exporters reduce the direct costs of storing and managing inventory.
Appropriate insurance should be in place to mitigate the risk of non-payment.
 Selecting the correct method of payment

The most important factors to consider in selecting the correct mode

of payment are:
The country risk
The buyer’s bank’s reputation
The credit worthiness of the buyer
The competition
The volume and value of the shipment
A aforementioned points have been briefly explained below:
• The country risk
buyer’s country has the ultimate control over the exchange and
release of dollars,
hold onto certain minimum of hard currencies i.e. dollar to pay
debts and obtain other financing.
• The buyer’s bank’s reputation:
if the payment is on L/C, buyer’s bank’s reputation and financial
stability matters.
seller might also recommend the buyer to use bank the
recommended bank only.
• Credit worthiness of the buyer:
if the buyer has good credit, they usually are readily able to prove it.
• The competition:
buyer’s might agree to the seller’s term over the competition.
buyer’s bank can offer great assistance in guiding in those
situations.
• The volume and value of the shipment:
larger the shipment, the higher the value.
consider cash in advance, partial deposit, L/C if shipment is going to
have adverse impact on the daily operation.
 Trade payment and financing mechanism through L/C

"A letter of credit is a document that guarantees the buyer's payment to the
sellers."
In other words, it is essentially a financial contract between a bank, a bank's
customer and a beneficiary.
It is issued in accordance with the provisions contained in ‘uniform custom and
practice for documentary credits’ published by the International Chamber of
Commerce.
It is a undertaking by a commercial bank to make payments on behalf of buyer
(importer) to the beneficiary (exporter) under the agreed terms and conditions of
sales between them.
Important features of L/C
• Protection
• Benefits to both importer and exporter
• It can be opened with goods shipment validity of 45, 90 and 180 days.
 Collateral and charges
• LC is issued against collateral--Bank deposit, FD
• Bank charges a fee for issuing letter of credit
• Fundamental concept of International trade
• guidelines issued by International chambers of commerce (ICC)
Correctness of LC
• name of seller, date, amount, product name, quantity, other details precise
and clear
• slight mistakes in LC, i.e. name, product, banks will not make payment
• All parties in LC dear in documents and not good and service
• payment will not depend on defects in goods and services
 Types of L/C
• Revocable L/C
which can be revoked without prior notice to the seller or exporter.
• Irrevocable L/C
it cannot be revoked with the prior consent of the seller or exporter.
it is normally/widely used around the world.
Advantages of LC
For Seller
• protection against buyer's payment default
• reduced production risk in case order is changed or cancelled
For buyer
• certainty of goods to be received
• LC shows solvency for the buyer and allows the buyer to reduce or eliminate
initial payment
Figure: How Letter of Credit works
Figure: Letter of Credit (L/C)
 Steps in L/C process
• Based on prior communication, importer and exporter agree on specifications. Agree
on agreement.
• Importer request his bank (issuing bank) to provide or open L/C in the name of
exporter with detailed terms and conditions.
• The correspondent bank delivers L/C to the exporter or to his assigned bank.
The correspondent bank provides credit against L/C at the prevailing interest
rate and other terms and conditions to finance the working capital.
• Exporter will ship the goods directly delivers goods to the transporter for shipment
along with bill of lading (B/D), invoice, certificate of origin to the importer in specified
destination.
• Exporter presents/submits all documents to the correspondent bank for credit
payment. May ask for bank guarantor of issuing bank.
• The correspondent bank will then forward all documents the issuing bank.
• The issuing bank forward payment to the correspondent bank for settlement.
• After that, the importer goes to the transporter with documents to receive the goods
after complying customs formalities.
 Global financial system

• The global financial system is the worldwide framework of legal

agreements, institutions, and both formal and informal economic
actors that together facilitate international flows of financial capital
for purposes of investment and trade financing.

• A financial system is the set of global, regional, or firm-specific

institutions and practices used to facilitate the exchange of funds.
• Financial systems can be organized using market principles, central
planning or a hybrid of both.
• Institutions within a financial system include everything from banks to
stock exchanges and government treasures.
• Financial markets involve borrowers, lenders, and investors negotiating
loans and other transactions.
Figure: Global financial system
 Global capital markets and financial institutions

• A capital market is a financial market in which long-term debt (over a

year) or equity-backed securities are bought and sold.
• Capital markets are where savings and investments are channeled
between suppliers--people or institutions with capital or lend or
invest--and those in need.
• Global Capital markets are a place where savings meet investment.
The global capital markets can be divided into:
Euro currencies
International bonds markets
Equity or Stock markets
International financial institutions
• Eurocurrencies markets:
A Euro currency is any currency banked outside of its country of origin.
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.
all deposits of foreign currency in London by a Nepali company are Euro
currencies.
hedge fund--is an official partnership of investors who
pool money together to be guided by professional management
firms---i.e. mutual funds.
• Equity securities and stock exchange markets
Equity securities represent ownership claims on a company's net assets.
A stock exchange facilitates stock brokers to trade company stocks and other
securities. A stock may be bought or sold only if it is listed on as exchange.
The stock market refers to public markets that exist for issuing, buying and
selling stocks that trade on a stock exchange or over-the-counter.
i.e. New York Stock Exchange, Tokyo stock exchange, etc.
• International bond markets
The international bond market is a market for bonds that are traded beyond
national boundaries.
They pull together investors from different countries.
The bonds which are traded in international bond markets are called international
bonds.
It can be divided into three types
Foreign bonds
Foreign bonds are sold outside of the country of the borrower but in the currency of
the country of issue.
Eurobonds
A Eurobond is a debt instrument that's denominated in a currency other than the
home currency of the country or market in which it is issued.
A Eurobond is an international bond that is denominated in a currency not
native to the country where it is issued.
Global bonds
A global bond is registered in different national markets according to the registration
requirements of each market.
 International economic institutions
1). World Bank
The world bank was established in July, 1, 1944 by a conference of
44 governments held in Bretton Woods, New Hampshire, USA.
Meanwhile, it has 190 member countries (Andorra, 16 October 2020)
• It is one of the largest sources of funding and knowledge to support
the members in the social, infrastructure sectors i.e. education, health,
water, energy, and environment.
• It’s an international financial institution that provides leveraged loans
to developing countries for capital programs.
• It has expanded from one institution to five development institutions.
• Each institution plays a different but collaborative role in advancing the
vision of inclusive and sustainable globalization.
 Five different institutions of World Bank Group (WBG)

• International for Reconstruction and Development (IBRD)

Established in 1945, provides debt financing on the basis of sovereign
guarantees.
• International Finance Corporation (IFC)
established in 1956, provides various forms of financing without sovereign
guarantees,
primarily to private sectors.
• International Development Association (IDA)
established in 1960, provides interest free loans and grants usually with
sovereign guarantees.
• International Centre for Settlement of Investment Disputes (ICSID
established in 1966, works with government to reduce investment risks.
• Multilateral Investment Guarantee Agency (MIGA):
established in 1988, provides insurance against certain types of risks i.e.
political risk, primarily to private sector.
 Objectives of World Bank
Its main objective is to provide financial assistance to reduce the poverty
through promotion of sustainable economic growth in developing
countries.
• Support for reconstruction and development of member countries
• To promote private foreign investment
• To provide financial assistance to member states for productive
purposes
• To promote long-range balanced growth of international trade
• Provide low interest loans interest free credit and grants
• Improve education, health and infrastructure of the developing and
poor countries.
• Helps for maintaining the balance of payment
 Functions of World Bank

The main function of the World Bank are as follows

• Provision of low interest loans
• Interest free as well as aids to the least developed countries for
development i.e. education, health, public administration,
infrastructure, financial and private sector development, agriculture
and environmental and natural resource management.
• Provides loans at preferential rates to member countries.
• Grants to poorest countries.
• Loans or grants for specific projects linked to wider policy changes in
sector or economy.
• Focuses on achievement of the Millennium Development Goals which
call for elimination of poverty and sustained development.
 Other functions of World Bank are as follows:
• Investment in People
i.e. human development, health care, nutrition, children,
education, social security, pension system among others.
• Agriculture development and environment protection
i.e. for poverty reduction in partnership with other agencies
• Private sector growth
creating investment friendly climate
• Fighting corruption
i.e. for good governance through better regulations, transparency
• Infrastructure development
• Others, including resolving conflicts, combating HIV/AIDS and
leveraging investment.
 Structure of World Bank
It consists of Board of Governors, Board of Directors and President.
• Member countries govern the World Bank Group through the Board of Governors and Boards of
Executive Directors.
• These bodies make all major decisions for the organizations.
• To become a member of the Bank, under the IBRD Articles of Agreement, a country must first join
the IMF.
• Membership in IDA, IFC, MIFA are conditional on membership in IBRD.
Board of Governors
World Bank is like a cooperative, where member countries are shareholders.
governors are member countries ‘minister of finance.’
Responsibilities and duties of governors
it is the highest policy making body of the bank, overall authority of
management of bank.
delegate specific duties to the Executive Directors
meet once a year at Annual Meeting of BoG of WB and IMF.
• Board of Directors
it’s main executive body of the bank.
24 ED make up the Board of Directors (BoD).
Five largest shareholders, France, Germany, Japan, UK, USA
appoint ED, while other member countries are represented by 19
executive directors.
main responsibilities of BoD are:
normally meet at least twice a week
over the bank’s business, i.e. approval of loans and guarantees,
new policies, administrative budge, country assistance strategies,
borrowing and financial decisions.
ED/BoD select a president who serve as chairman of the Board.
responsible for an audit of account. Approve the appointment and
mandate of the external Auditor which is rotated every five years.
• President
elected by the Board of Directors for a five-year term, renewable
term.
US being the largest shareholders, by tradition, the Bank President is
a US National and is nominated by the US.
David Robert Malpass, former Under Secretary of the US Treasury
for International Affairs, is serving as President of WBG since 2019.
Chairs the meets of both BoG and BoD and responsible for overall
management of the bank.
there are 24 vice-presidents, three senior vice-presidents and two
executive vice-presidents.
 Fund generation in WBG
• Selling AAA-rated bonds in the world’s financial markets.
(AAA-rated bonds have a high degree of creditworthiness because
their issuers are easily able to meet financial commitments and have the
lowest risk of default.
• IBRD earns small margin on lending, lending out its own capital
• IDA, largest source of interest-free loans and grant to poor nations, funds are
provided every three years by 40 donor countries.
• Regenerated through repayment of loan principal on 35 to 40 years.
• Other sources include
funds raised in the financial markets, earning from on its investment,
from fees paid by member countries, contribution made by richer nation,
borrowing countries themselves when they pay back their loans.
• Trust funds
• IDA accounts for more than 40% of WB lending.
 Challenges of WB
• Poverty reduction and sustainable growth in poorest countries.
• Solutions to the special challenges of post-conflict and fragile states.
• Development solutions with customized services and financing of middle-income
countries.
• Regional and global issues that cross national borders-climate change, infections and
diseases and trade
• Greater development and opportunity in the Arab world.
• Pulling together the best global knowledge to support development.
Criticism of WB
• Free market reform policies
• Formulaic recipes of ‘development’
traditional values are abandoned.
• Dual roles
i.e. political and practical organization.
• Leadership, environmental strategy
 International Monetary Fund (IMF)

“It is the central institution of the international monetary system-the system of

international payments and exchange rates.”
• Established in 1 July, 1944, with representatives of 44 governments in Bretton
Woods, New Hampshire, USA.
• Came into existence in December 1945, as UN specialized agency after 29 member
countries signed its ‘Article of Agreement.’
• Promote world economy health for sustainable economic growth, raise living
standard of people.
• IMF aims to
Prevent crisis in the system by encouraging countries to adopt sound economic
policies.
Provides policy advice that foster economic stability, reduce their vulnerability to
economic and financial crisis.
Provide funds to address balance of payment problems
Also promotes for stability of exchange rate, balanced expansion of world trade,
avoidance of competitive devaluations, orderly correction of BOPs problems.
 How IMF serves its members
• Advice on policies and global oversight:
reviews and monitors national and global economic, financial
developments,
advice on their economic policies.
IMF conducts its oversight on three ways:
country surveillance
global surveillance
regional surveillance
• Lending in hard currency:
to support adjustment and reform policies
to resolve the balance of payments problem
to ease adjustment to bring its spending in line with its income
to support policies including structural reforms for sustainable growth
• Lending in hard currency:
IMF lending falls into three categories:
Stand-by arrangements:
deals with short-term balance of payments problems
supplemental reserve facility was formed to provide large loans with
short maturities to countries going through capital amount crisis.
Extended fund facility:
address balance of payments difficulties related to structural
problems
measures to improve the tax and financial sector reforms, privatization of
public enterprises and steps to make labor market flexible.
Poverty reduction and growth facility
provides concessional loans with annual interest rate of 0.5 per cent
and maturity of 10 years.
Exogenous shocks facility provide loans to countries not receiving
funds from Poverty Reduction and Growth Facility
 IMF also provides Emergency Assistance to countries coping with
BOPs problem due to natural disasters or military conflicts.
Trade Integration Mechanism allows IMF to provide loans to
developing countries hit by BOPs problems owing to multilateral trade
liberalization.
decline in export earning after loosing preferential access to market
prices go up when agricultural subsidies are eliminated.
• Strengthening monetary and financial system:
collaborates with WBG, regional development banks, WTO, UN
agencies for strengthening world monetary and financial system.
collaborates with WB on poverty reduction, social policies and
financial sectors, development of standards of codes, improvement of
quality, availability and coverage of data on external debt.
works with standard-setting bodies i.e. Basel Committee on Banking
Supervision and International Association of Insurance supervisors.
• Technical Assistance and Training:
provides assistance in the following four main areas:
Monetary and financial policies i.e. banking system supervision,
restructuring foreign management and operations, clearing
settlement systems for payments and structure development of central
bank.
Fiscal policy and management i.e. tax and customs policies and
administration, budget formulation, expenditure management, design of
social safety nets and management of domestic and foreign debt.
Compilation, management, dissemination, and improvement of
statistical data, and
Economic and financial legislations.
 Structure of IMF

• The board of governors:

each member country appoints a Governor i.e. minister of finance
or the governor of its central bank.
all members decides on major policy issues, the highest authority
governing the IMF.
delegates day-to-day decision-making to the executive board.
usually meets once a year.
• International monetary and financial committee:
joint committee of the Board of Governors of the IMF and WB
known as ‘Development committee’ advices and reports to the
governors on development policy to developing countries.
key policy issues of IMS are considered twice-yearly in the IMF and
Financial committee.
• The Executive Board
consists of 24 Executive Directors with MD as Chairman and three
deputy managing directors.
usually meets three times a week.
5 largest shareholders---USA, Japan, Germany, France and UK
along with China, Russia, Saudi Arabia have their own seat on the
Board.
16 executive directors are elected for two-year terms by group of
countries known as constituencies.
the Board of Governors delegates powers of the EB to conduct the
IMF business.
 Asian Development Bank (ADB)

‘ADB is an international development finance institution.’

• It is a regional development bank formally established in 1966 to
promote economic and social development in Asia and Pacific
countries through loans and technical assistance.
• Nepal is a founding member of the ‘Asian Development Bank’ having
5202 (o.15%) shares and 18,434 (0.42%) votes.
• The assistance is focused on agriculture and natural resources,
education, water supply and other municipal infrastructure, services,
transport, information and communication technology, finance,
energy, public sector management climate change, social protection.
• Vision: an Asia and pacific free of poverty
• Mission: help developing member countries improve the living
conditions and quality of life of their people
 Objectives of ADB
The main purpose of ADB for the countries in the Asia Pacific region are:
• Provide loans and equity investment to its developing member countries.
• Provide technical assistance for planning and execution of development projects and
programs for advisory services.
• Assist in coordinating development policies and plans of its DMCs.

Functions of ADB
• To promote investment in the region of public and private capital for development
purposes
• To utilize the resources and its disposal for financing development of the DMCs in the
region i.e. regional, sub-regional or national projects for economic growth
• To assist member countries in the coordination of their development policies and plans
with a view of achieving better utilization of their resources.
• Promoting the orderly expansion of their foreign trade, in particularly, intra-regional
trade.
• To co-operate with other development partners to foster development opportunities for
investment and assistances in DMCs.
“ADB assist its members, partners, by providing loans, technical assistance, grants and
equity investment to promote social and economic development.”

ADB organization structure

• The highest policy-making body of the bank is the ‘Board of Governors’ composed of
one representatives from each member state.
• The BoGs elect among themselves the 12 members of the ‘Board of Directors’ and
their deputy one by one.
• Eight of the 12 members come from regional (Asia and Pacific) while the others come
from non-regional members.
From 31 members at its establishment in 1966, ADB has grown to encompass 68
members of which 49 are from within Asia and Pacific and 19 outside.
• The BoGs elect the bank’s president, who is the chairperson of BoD and manages ADB.
• President has a term office lasting 5 years may be reelected.
• Japan is the largest shareholders of the bank, president has always been Japanese.
 WTO and Free Trade Policies
• After Uruguay Round negotiations on 15th December 1993, WTO replaced
GATT.
• Since 1st January 1995, WTO began its rule-based system of trade worldwide.
• Nepal got WTO membership in 23rd April 2004 as 147th nation out of 164
members, as of now.
• Dr Ngozi Okonjo-Iweala of Nigeria is the current Director General of WTO,
four year renewable terms.
• Irish Peter Sutherland was the first DG of WTO.
• It’s headquarter is situated in Geneva, Switzerland.
“It is the legal and institutional foundation of the multilateral trading system.”
• It provides the principal contractual obligations, determining how member
governments should frame and implement their national trade legislation and
regulation.
 Objectives of WTO
• Raising standards of living and incomes,
• Ensuring full employment, expanding production and trade
• Optimum use of world’s resources
• Sustainable development in line with protection and preservation of
environment
• Ensuring developing and least developed countries secure a better share
of the growth in international trade.
• Strengthen world economy through increase trade, investment,
employment and income growth.
 Functions of WTO
• Administering and implementing the agreements
• Provide a forum for multilateral trade negotiations
• Resolve trade disputes
• Review of national trade policies
• Assist developing countries in trade policy issues, through technical
assistance, training programs.
• Cooperate with other institutions i.e. UN, WB, IMF, Organization for
Economic Co-operation and Development (OECD), etc in global economic
policy-making.
• Provides predictable, transparent and improved rules for global business
liberalization through reduced tariffs, removed non-tariff barriers, and
increased fair and equitable competition.
 Features and structure of WTO agreements

WTO is “Rules-based”, its rules are negotiated agreements under international

business—goods, services and intellectual property.
General Agreement on Trade and tariffs (GATT)
General Agreement on Trade in Services (GATS)
Trade-Related Aspects of Intellectual Property Rights (TRIPS)
The main features of WTO agreements are:
• Principles of liberalization
• Permitted exceptions
• Commitments of individual countries to lower barriers and to open markets
• Procedures for settling disputes
• Special treatment for developing countries and
• Requirements for making national trade policies, rules and regulations
transparent.
Structure of WTO
• General Agreement on Tariffs and Trade (GATT):
it includes, Agriculture, Textile and clothing—market access
trade related investment measures, customs valuation procedures,
pre-shipment inspection, rules of origin, import licensing procedures,
technical barriers to trade among others.
• General Agreement on Trade-in-services (GATS):
Air transport, Financial services, shipping and telecommunications.
• Agreement on Trade related aspects of intellectual property rights:
• Other agreements are:
settlement of disputes, balance of payments, shifting of burden of
proof, binding of tariffs, state trading, agreement on trade policy review
mechanism, plurilateral agreements on civil aircraft and government’s
procurement.
• Agreement on dispute settlements etc.
(to change the responsibility of proving)
 Benefits of WTO
• Cut living costs and raise living standards
• Settle disputes and reduce trade tensions
• Stimulate economic growth and employment
• Cut the cost of doing business internationally
• Encourage good governance
• Help countries develop
• Give the weak a stronger voice
• Support the environment and health
• Contribute to peace and stability
• Be effective without hitting the headlines
 Principles of WTO
“The WTO agreements contain some 29 legal texts, and many ministerial
declarations, decisions and understandings.
• Undistorted flow of World Trade without Discrimination
• Freer trade—liberalized trade gradually, through negotiation
• Predictable and stable trading system and growing access to markets
through tariff binding and reduced non-tariff barriers.
• Promoting fair competition practice through trade remedy measures
and dispute settlement
• Encouraging socio-economic development and reform through special
and differential treatment (S&DT)
A aforementioned points have been briefly highlighted below:
“An intergovernmental organization concerned with the regulation of
international trade between nations”
Some of the important principles of WTO are as follws:
1. Undistorted flow of world trade without discrimination
Most favoured nation (MFN) treatment:
• it denotes the equal treatment of all countries
• it is a status given by a country to provide any concessions, privileges, or
immunities granted in a trade agreement
• the members of WTO agree to accord MFN status to each other.
• i.e. the same concessions, privileges, or immunities should be granted to all the
WTO member states, no any country should be discriminated.
National treatment:
• Non-discrimination between the domestic and imported products
• i.e. if tea is imported from Sri Lanka after paying all taxes at customs it should
not be subject to other sale tax, VAT, income tax etc.
2. Free trade---liberalized trade gradually, though negotiation:
• Quotas are outlawed,
• Tariffs are considered legal to protect domestic industries and to raise revenues
• Provisions have been made to introduce changes gradually through the process
of ‘progressive liberalization.’
3. Predictable and stable trading system and growing access to markets
through tariff binding and reduced non-tariff barriers:
• Ensures fair competitive trading practices with more choices and low price in
the markets.
• Tariffs or customs duties cannot be discriminatory among import sources
4. Promoting fair competition practices through Trade remedy measures and
dispute settlement:
• WTO is a rule-based system, dedicated to open, fair and undistorted
competition (usual).
• Rules on non-discrimination, subsidies and dumping –to secure fair conditions
for trade.
• Agreement on Agriculture (AOA) provides increased fairness in frame trade
• Agreement on Trade related intellectual property rights (TRIPS) improves
competition where ideas and inventions are involved
• General Agreement on Trade-in-services (GATS) commitments to liberalize
trade in services and provides a mechanism for resolving disputes between
countries.

5. Encouraging socio-economic development and reform through special

and differential treatment (S&DT):
• Extra flexibility to implement the agreements
• Longer time-frame in the implementation of market access concessions
• Seek technical part IV of GATT
i.e. not to expect reciprocity for concessions made to developing nations
provides permanent legal basis for market access concessions
under Generalized System Preferences (GSP).