BBA 6th Semester International Business Management (604) UNIT 1

Compiled by: Ankit Agarwal

Assistant professor

DS College, Aligarh

International Business
International Business means carrying of business activities beyond national boundaries. It is an
extension of domestic business, which includes the transactions of economic resources such as
goods, capital and services comprising of technology, skilled labour, transportation etc. It
includes not only international trade of goods and services, but also foreign investment.
International business is a term used to collectively describe the operations of firms with interests
in several countries. Simply, it is business beyond national or continental borders by firms. You
hear very often terms such as International competition, Multinational corporation, Transnational
deals, Globalization, Multi-domestic business models, Worldwide sales, dynamics of Global
Market place and so on daily. All these capture one or other issues concerning international
business. Success in international business requires more business acumen than managing a
domestic firm. Of course opportunities abound in the borderless world. So also the threats wield
an intimidating future. Firms must be able to reap the opportunities while ably negotiating with
the attending threats. Firms must not only deal with general business functions and values, but
also understand and work from a global perspective that adds multiple variables such as
divergent geo-political dynamics, multi-cultural nuances, volatile-financial conditions, different
time zones, and vast spatial- distance issues to the international business management equation.
Deftness and foresightedness are much needed for doing business across the globe.

International Business is a broad term, which includes all commercial transactions that take
place between nations. There are many ways to define international business. On one extreme
of the spectrum, we find the definition of international business in terms of exports and imports
and, on the other extreme, we find the definition of international business in terms of the
worldwide commercial activities which include transnational manufacturing, transnational
marketing, transnational organizing, transnational investment, transnational financing and
transnational servicing. Managing such a geographically spread business across different nations,
who is having different culture, political, legal and social system, is known as International
Business Management.

Definitions:
1. The Internet Public Library (IPL) defines International Business as , ‘doing
business in international markets, and business information specific to various
countries or geographic regions of the world’.

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2. John D Daniels and Lee H Radebaugh in their book, ‘International
Business’ define international business as, ‘all commercial transactions-
private and governmental-between two or more countries. Private companies
undertake such transactions for profit; governments may or may not do the
same in their transactions. These transactions include sales, investments and
transportation’.
3. According to International Business Journal, ‘International business is a
commercial enterprise that performs economical activity beyond the bounds of its
location, has branches in two or more foreign countries and makes use of economic, cultural,
political, legal and other differences between countries’.

Advantages/ opportunites of International Business: -

The main advantages of International Business are as follows:-
1. More variety of goods available for consumers.
2. Better quality of goods.
3. Competition both at the international level as well as local level.
4. Closer ties between nations.
5. More exchange of technical know-how.
6. Local producers will try to improve the quality of their products.
7. Increase in employment locally.
8. Enhances the domestic competitiveness.
9. Takes advantage of international trade technology.
10. Increase sales and profits.
11. Extend sales potential of the existing products.
12. Maintain cost competitiveness in your domestic market.
13. Enhance potential for expansion of your business.
14. Gains a global market share.
15. Reduce dependence on existing markets.
16. Stabilize seasonal market fluctuations.

Problems of International Business:

The main Problems of International Business are as follows:-
1. Local production may suffer.
2. Local industries may be overshadowed by their international competitors.
3. Rich countries may influence political matters in other countries and gain control over
weaker nations.
4. Ideological differences may emerge between nations with regard to the procedures in trade
practices.
5. International business firms have to meticulously maintain quality of the product based on
quality norms of each country.
6. Political instability is the major factor that discourages the spread of international business.
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7. The developing countries with less purchasing power are lured into a debt trap due to the
operations of MNCs in these countries.
8. Governments of various countries impose tariffs, import and export quotas and trade barriers
in order to protect domestic business.

Challenges of international business

Language Barriers

Did you know that 75% of British adults can’t speak a foreign language competently and 75% of
American adults speak only their native tongue? And yet, there are over 7,000 languages and
dialects spoken around the world.

In global business, it’s very common to meet people who speak a different language than you.
And language barriers can make doing business internationally very difficult. For this reason,
most international companies look for employees who are fluent in at least one foreign
language.

At Thunderbird, we understand the importance of language in international business. That’s why

we require our Master of Global Management students to be proficient in a foreign language
upon graduation.

But language study isn’t just about language proficiency. Language study also helps expand
Global Mindset – “being comfortable with being uncomfortable,” as Thunderbird professor
Mansour Javidan says.

Learning a new language also provides cultural knowledge. That leads us to another challenge
of international business—working with people from different cultures.

Cultural Differences

Oxford defines culture as: “the customs, arts, social institutions, and achievements of a particular
nation, people, or other social group.” Each country, sometimes each region within certain
countries, has a unique culture. Having an understanding of different cultures makes the
management of cross-cultural business relationships and leading global companies much easier
and more effective.

For example, different countries have different greetings. In the United States or Russia, the
appropriate greeting is a handshake. However, in China and India the appropriate greeting is a
bow. Meanwhile, in Brazil or much of Europe, the appropriate greeting is a kiss or brush on the
cheek. The same nuances can be found in many other business-related customs – business
meetings, business dinners, and workday or workweek length for example. Working across
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borders is also essential for success in areas such as global strategy, mitigating political risk, and
other contemporary challenges.

At Thunderbird, we think the best way to learn about other cultures is through real-time
interactions. Our international student and faculty population makes it easy for students to
interact with people from all over the world on a daily basis. We also have many applied learning
courses and study abroad opportunities where students are immersed in other cultures.

We believe celebrating different cultures expands and grows our knowledge, our compassion and
our communication while supporting our vision: “A world with inclusive and sustainable
prosperity.” Learn more about how you can develop cultural dexterity at Thunderbird.

Managing Global Teams

Developing and managing successful teams is hard enough. When you add language barriers and
cultural differences along with varying time zones and levels of technology access, it becomes
even more challenging.

Cultivating the right mindset and skillset makes the often tricky management of global teams
easier. Leaders who develop a Global Mindset have a limitless resource for understanding
diverse cultures and business environments and are emotionally intelligent. They are highly
flexible and understand how to navigate through varied business and interpersonal
interactions. Global Mindset plays an important role in global leadership and management.

Another key to managing global teams is having the right skillset. Empathy and compassion,
communication, technological intelligence, agility and flexibility, and lifelong learning are some
of the important skills that leaders and managers need to lead global companies and other
transnational enterprises.

Political and Legal Nuances

The international business environment is highly influenced by political and legal nuances and
foreign relations. When you're doing business in a foreign market, it's important to have a deep
understanding of policies, financial systems, and country-specific tax implications. Having this
knowledge will influence your strategy and ensure you're operating within the laws and
regulations of the country.

Studying international business at Thunderbird prepares future leaders to navigate these nuances.
Through our applied learning programs and simulated experiential learning, students gain real-
world experience solving these challenges in corporate, government, or nonprofit settings.

Brand Consistency

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When we talk about brand consistency, that covers everything from language and logo to
company culture. Because multinational companies are navigating so many variables, it can be
challenging to create brand consistency and balance that with cultural nuances. Developing an
international corporate strategy is imperative.

A company’s brand is what sets it apart from competitors. It’s like a company’s fingerprint. Take
Starbucks for example. If you walk into a Starbucks, you expect the same “legendary
experience” and drink recipe regardless of where you are in the world. That consistency is what
creates trust and loyalty with Starbucks’ customers and partners. But not all companies have had
the same success.

In the 1970s, Procter and Gamble Co. tried to enter Japan's notoriously demanding market with
their new disposable diapers. They showed ads of storks delivering diapers – imagery that
resonated well with U.S. parents. Japanese parents on the other hand were stumped by the sight
of this strange bird.

In Japanese folklore, babies are delivered not by a stork, but by a giant peach floating down the
river. The international marketing team failed to do their homework and it cost P&G a lot of
international business. Developing a new strategy that balanced consistency with sensitivity to
the unique Japanese culture helped them turn things around.

Finding this balance across a global organization starts at the top and takes time and attention to
cultivate. It takes leaders who communicate, teach and exemplify brand standards, and ensure
that their teams are doing the same. At Thunderbird, we believe in that same consistency with
our own brand and work purposefully to create a consistent experience and education whether
you’re in Phoenix or Dubai.

International business is exciting and evermore prevalent in our global world. It also comes with
many challenges. Our goal at Thunderbird is to make it less intimidating by preparing our
students to lead and manage across borders.

Need of International Business

International Business has gained wide popularity, because of the growing rate of multinational
enterprises. During the last-three decades, the field of modern International business began to
develop. Today, it has become a separate field of study in the management courses.

1. To Achieve Higher Rate of Profits: The basic objective of the business firms is to earn
profits. When the domestic markets do not promise a higher rate of profits, business firms
search for foreign markets that hold promise for higher rate of profits. Thus the objective of
profit affects and motivates the business to expand its operations to foreign countries.

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2. Expanding the Production Capacities beyond the Demand of the Domestic Country:
Some of the domestic companies expanded their production capacities more than the demand
for the product in the domestic countries. These companies, in such cases, are forced to sell
their excess production in foreign developed countries.
3. Availability of Technology and Competent Human Resources: Availability of advanced
technology and competent human resource in some countries act as pulling factors for
business firms from the home country. The developed countries due to these reasons attract
companies from the developing world.
4. To Achieve Higher Rate of Economic Development: International business helps the
governments to achieve higher growth rate of the economy, increase the total and per
capita GDP, industrial growth, employment and income levels.
5. Easy supply of Raw Materials: The source of highly qualitative raw materials and bulk raw
materials is a major factor for attracting the companies from various foreign countries. Most
of the US based and European based companies located their manufacturing facilities in
Saudi-Arabia, Bahrain, Qatar, Oman, Iran and other Middle East countries due to the
availability of petroleum. These companies, thus, reduced the cost of transportation.
6. Availability of Quality Human Resources at Less Cost: This is a major factor, in recent
times, for software, high technology and telecommunication companies to locate their
operations in India. India is a major source for high quality and low cost human
resources unlike the USA, developed European countries and Japan. Importing human
resources from India by these firms is costly rather than locating their operations in India.
Hence, these companies started their operations in India, China and Thailand.
7. Liberalization and Globalization: Most of the countries in the globe liberalized their
economies and opened their countries to the rest of the globe. These changed policies
attracted the multinational companies to extend their operations to these countries.
8. To Increase Market Share: Some of the large-scale business firms would like to enhance
their market share in the global market by expanding and intensifying their operations in
various foreign countries.
9. Severe Competition in the Home Country: The weak companies which could not meet the
competition of the strong companies in the domestic country started entering the markets of
the developing countries.
10. Limited Home Market: When the size of the home market is limited either due to the
smaller size of the population or due to lower purchasing power of the people or both,
the companies internationalize their operations.
11. Tariffs and Import Quotas: It was quite common before globalization that governments
imposed tariffs or duty on imports to protect the domestic company. Sometimes Government
also fixes import quotas in order to reduce the competition to the domestic companies from
the competent foreign companies. These practices are prevalent not only in developing
countries but also in advanced countries.

Similarities between Domestic Business and International Business

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International Business is an extension of Domestic business. Today, all types of business
enterprises are inspired to carry on business across the globe. Both International Business and
Domestic Business are similar in some ways. Such as: –
1. Business whether domestic or international, involves buying and selling of goods and
services.
2. Both in domestic as well as International Business success depend upon satisfying the
customers.
3. Profit earning is the main objective of every business, whether it is domestic or international.
4. Building goodwill is another common objective of both the business.
5. Research and development for product improvement and adaption is necessary in both
businesses.
6. Business concepts, processes and principles are universally applicable, and the marketer’s
task is same in both.

Difference between Domestic Business and International Business: -

[Link]. Domestic Business International Business
1. Business rules are Standarised & Matured. Business rules are highly diverse & unclear.
2. One language and culture. Many languages and differences in culture.
3. Uniform financial climate. Varied financial climate.
4. Patriotism helps. Patriotism hinders.
5. Single currency and taxation system. Multiple currencies and taxation system.
6. Descriptive approach to study. Integrative approach to study.
7. Product planning and development Product Planning & development according
according to domestic markets. to foreign markets.
8. Relatively stable marketing environment. Multiple and Unstable Marketing
environment.
9. Control of business activities is easy. Control of business activities is difficult.
10. It is carried within the nation’s boundaries. It is carried across the nation’s boundaries.

Different stages of Internalization process?

The internationalization process generally includes five stages includes: - Domestic Company,
International Company, Multinational Company, Global Company and Transnational Company.

1. Domestic Company

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Domestic company limits its operations, mission and vision to the national political boundaries.
These companies focus its view on the domestic market opportunities, domestic suppliers,
domestic financial companies, domestic customers etc.
These companies analyze the national environment of the country; formulate the strategies to
exploit the opportunities offered by the environment. The domestic companies think that ‘if it is
not happening in the home country, it is not happening’.
The domestic company never thinks of growing globally. If it grows, beyond its present capacity
the company selects the diversification strategy of entering into new domestic markets, new
products, technology etc. The domestic company does not select the strategy of
expansion/penetrating into the international market.

2. International Company
Some of the domestic companies which grow beyond their production and/or domestic
marketing capacities think of internationalizing their operations. Those companies who decide to
exploit the opportunities outside the domestic country are the stage two companies. These
companies remain ethnocentric or domestic country oriented. These companies believe that the
practices adopted in domestic business, the people and products of domestic business are
superior to those of other countries. The focus of these companies is domestic but extends
the wings to the foreign countries.
These companies extend the domestic product, domestic price, promotion and other business
practices to the foreign markets. Normally, internationalization process of most of the global
companies starts with this stage. Most of the companies follow this strategy due to limited
resources and also to learn from the foreign markets gradually before becoming a global
company without much risk.

3. Multinational Company
Sooner or later, the international companies learn that the extension strategy (i.e. Extending the
domestic product, price and promotion to foreign markets) will not work. Therefore, approach
shirts to polycentric.
This stage of multinational company is also referred to as ‘multi-domestic’. Multi-domestic
company formulates different strategies for different markets, thus, the orientation shifts from
ethnocentric to polycentric. Under this stage, the offices/branches/subsidiaries of a
multinational company work like domestic company in each country where they operate with
distinct policies and strategies suitable to that country concerned. Thus they operate like a
domestic company of the country concerned in each of their market.

4. Global Company
A global company is the one which has either global marketing strategy or a global production
strategy. Global company either produces in home country or in a single country and focuses on
marketing these products globally, or produces the products globally and focuses on marketing
these products domestically or in a single country.
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Under this stage approach remains a mix of region-centric and geocentric. Global companies are
having a global mindset with a single global product, which means their product offering
remains same throughout the world. One of example of such company is Harley Davidson.

5. Transnational Company
Transnational company produces, markets, invests and operates across the world. It is an
integrated global enterprise which links global resources with global market at profit.
Under this stage, companies adapt to local needs while having a global mindset at the same time.
Such companies do not have any home country. They do not differentiate between countries on
non-commercial grounds. Long-term global policies of such companies remain same throughout
the globe. There is not pure transnational company, but practically large MNCs contributing a
significant portion of world’s GDP are termed as transnational company.

Forms of International Business

International business can take different forms. The choice of form is very important. The desire
to be close the market, tariff barriers, risk diversification and increased potential to reach other
neighboring markets in due course will make a firm choose ownership forms. Basically it
classified into two categories: -

1. Ownership (Or Foreign Direct Investments) Forms:

Ownership form involve when the firm decides to own production / distribution facility in the
foreign land. Eventually foreign investment gets involved. There are many alternatives like
Wholly Owned Subsidiaries, Joint Ventures, Strategic Alliances, Merger and Acquisition, etc.
A. Wholly Owned Manufacturing Facilities: Companies with long term and substantial
interest in the foreign market normally establish fully owned manufacturing facilities there.
As Drucker points out, “it is simply not possible to maintain substantial market standing in
an important area unless one has a physical presence of a producer”. A number of factors like
trade barriers, differences in the production and other costs, government policies, etc.,
encourage the establishment of production facilities in the foreign markets.
B. Assembly Operations: As Miracle point out, a manufacturer who wants many of the
advantages that are associated with overseas manufacturing facilities and yet does not want
to go that far may find it desirable to establish overseas assembly facilities in selected
markets. In a sense, the establishment of an assembly operation represents a cross between
exporting and overseas manufacturing.
C. Joint Venture: Joint Venture is a very common strategy of entering the foreign market. In
the widest sense, any form of association which implies collaboration for more than a
transitory period is a joint venture (pure trading operations are not included in this concept).
D. Third Country Location: Third country location is sometimes used as an entry strategy.
When there are no commercial transactions between two nations because of political reasons
or when direct transactions between two nations are difficult due to political reasons or the

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 like, a firm in one of these nations which wants to enter the other market will have to operate
from a third country base.
E. Mergers & Acquisitions: Mergers & Acquisitions have been a very important market entry
strategy as well as expansion strategy. A number of Indian companies have also used this
entry strategy.
F. Strategic Alliance: Strategic alliance has been becoming more and more popular in
international business. This strategy seeks to enhance the long term competitive advantage of
the firm by forming alliance with its competitors, existing or potential in critical areas,
instead of competing with each other

2. Non-Ownership Forms: -
Non-ownership forms involve doing international business without ownership interests in the
foreign countries concerned. These are

A. Merchandize Exporting, Importing and Counter Trade: In Economics, exchange of

physically tangible goods between countries, involving the export, import, and re-export of
goods at various stages of production is referred to trade in merchandize or tangible or
visible items. Merchandize trade is distinguished from invisible trade, which involves the
export and import of physically intangible items such as services (covering receipts and
payments arising from activities such as customer service or shipping, income from foreign
investments, etc).
Exporting and Importing are the basic and fundamental limbs of international business by
a firm. These are the most traditional mode of entering the international market. Resulting
international trade has been growing much faster than the world output resulting in greater
world economic integration.
Counter Trade is used as a strategy to increase exports, particularly by the developing
countries. Counter trade has been successfully used by a number of companies as an entry
strategy.
B. Licensing and Franchising: Licensing and franchising, which involve minimal
commitment of resources and effort on the part of the international marketer, are easy ways
of entering the foreign markets. Under international licensing, a firm in one country (the
licensor) permits a form in another country (the licensee) to use its intellectual property
(such as patents, trademarks, copyrights, technology, technical know-how, marketing skill
or some other specific skill). The monetary benefit to the licensor is the royalty or fees
which licensee pays. In many countries, such fees or royalties are regulated by the
government; it does not exceed five per cent of the sales in many developing countries. A
licensing agreement may also be one of cross licensing, wherein there is a mutual exchange
of knowledge and/or patents.

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C. Contract Manufacturing: Under Contract Manufacturing, a company doing international
marketing contracts with firms in foreign countries to manufacture or assemble the products
while retaining the responsibility of marketing the product. This is a common practice in
international business.
D. Management Contracting: Under the Management Contract, the firm providing the
management know-how may not have any equity stake in the enterprise being managed. In
short, in a management contract the supplier brings together a package of skills that will
provide an integrated service to the client without incurring the risk and benefit of
ownership.
E. Turnkey Contracts: A turnkey contract means that the contractor will do all the work
needed to fix up a working network for you. All you have to do is ‘Open the Door’ or ‘Turn
the key’ and step into a working system. Turnkey contracts are common in international
business in the supply, erection and commissioning of plants, as in the case of oil refineries,
steel mills, cement and fertilizer plants etc; construction projects and franchising
agreements.

Theories of International Trade

Mercantilism
Mercantilism is an economic theory that emphasizes self-sufficiency through a favorable
Balance of Trade (BOT). The balance of trade (BOT), also known as the trade balance, refers to
the difference between the monetary value of a country’s imports and. Mercantilist policies focus
on the accumulation of wealth and resources while maintaining a positive trade balance with
other countries. By maximizing exports and minimizing imports, mercantilism is also viewed as
a form of economic protectionism.

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Originating in 16th-century Europe, mercantilism is now viewed as a mostly outdated economic
theory, replaced by the supply and demand forces of the market economy. Market economy is
defined as a system where the production of goods and services are set according to the changing
desires and abilities of. Present-day mercantilism commonly refers to economic policies that
restrict the importation of foreign goods.

Summary
Mercantilism is an economic theory that emphasizes self-sufficiency through a favorable balance
of trade.
Mercantilist economic policies rely on government intervention to restrict imports and protect
domestic industries.
Modern-day mercantilist policies include tariffs, subsidizing domestic industries, devaluation of
currencies, and restrictions on the migration of foreign labor.

History of Mercantilism
Originating in 16th-century Europe, mercantilism began with the emergence of the nation-state.
The dominant economic theory was that the global supply of wealth was finite, and it was in the
nation’s best interest to accumulate as much as possible. During that time, wealth was measured
by a country’s quantity of silver and gold. To accumulate more wealth, European countries, such
as Britain and France, would focus on maximizing their exports and minimizing imports, which
resulted in a favorable balance of trade.

For countries with a negative trade balance with a mercantilist country, the difference would be
paid back in silver or gold. To maintain a favorable trade balance, the early mercantilist countries
would enact imperialist policies by setting up colonies in smaller nations.

The aim was to extract raw material to send back to the home country, where it would be refined
into manufactured goods. The goods would then be resold to the colonies, allowing early
mercantilist nations to accumulate wealth through a positive trade balance.

Absolute advantage theory

Absolute Advantage

In 1776, Adam Smith questioned the leading mercantile theory of the time in The Wealth of
[Link] Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (London:
W. Strahan and T. Cadell, 1776). Recent versions have been edited by scholars and
economists. Smith offered a new trade theory called absolute advantage, which focused on the
ability of a country to produce a good more efficiently than another nation. Smith reasoned that
trade between countries shouldn’t be regulated or restricted by government policy or
intervention. He stated that trade should flow naturally according to market forces. In a

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hypothetical two-country world, if Country A could produce a good cheaper or faster (or both)
than Country B, then Country A had the advantage and could focus on specializing on producing
that good. Similarly, if Country B was better at producing another good, it could focus on
specialization as well. By specialization, countries would generate efficiencies, because their
labor force would become more skilled by doing the same tasks. Production would also become
more efficient, because there would be an incentive to create faster and better production
methods to increase the specialization.

Smith’s theory reasoned that with increased efficiencies, people in both countries would benefit
and trade should be encouraged. His theory stated that a nation’s wealth shouldn’t be judged by
how much gold and silver it had but rather by the living standards of its people.

Theory of Comparative Cost Advantage:-

David Ricardo the English economist illustrated this theory in 1817. He illustrate that trade
between nations can be profitable even if one of the two nations produces both the commodities
more efficiently than the other nation provided that it can produce one of these commodities with
a comparatively greater efficiency than the other commodity.
The law of comparative advantage indicates that a country should specialize in the production of
that commodity in which it is more efficient and leave the production of the other commodity in
which it is less efficient even if that country has an absolute advantage in both the commodities.
It makes sense for a country to specialize in the production of those goods that it produces most
efficiently and to buy the goods that it produces less efficiently from other countries. The two
nations will then have more of both goods by engaging in trade.

Country No. of units of labor No. of units of labor Exchange ratio between Wine
per unit of Cloth per unit of Wine and Cloth
England 100 120 1 Wine: 1.2 Cloth
Portugal 90 80 1 Wine: 0.88 Cloth

From the above example, it is evident that Portugal has an absolute superiority in both the
branches of production, even Portugal has to concentrate on the production of wine only in
which it has greater comparative advantage over England, and import all her cloths from
England even if it can produce cloth more efficiently than England. Similarly, England has to
concentrate on the production of cloth and imports all of her wine from Portugal which has a
great comparative advantage in the production of wine.

Each country’s resources would shift to the efficient industries because the country could not
compete in the inefficient ones. Through specialization, countries could increase their efficiency
because of three reasons:-

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1. Labor could become more skilled by repeating the same tasks.
2. Labor would not lose time in switching from the production of one kind of product to another.
3. Long production runs would provide incentives for the development of more effective
working methods.

A country could then use its excess specialized production to buy more imports than it could
have otherwise produced.

Some Assumptions of Comparative cost advantage theory are:-

 Labor is the only element of cost of production.

 Production is subject to the law of constant returns.
 International Trade is free from all barriers.
 No transportation cost.
 Labor is perfectly mobile within the country but perfectly immobile between countries.
 Labor is homogeneous.
 There is full employment.
 The international markets are perfect so that the exchange rate of the two commodities is
same.

Heckscher Ohlin Theory or Factor Endowment Theory

This theory was developed by Swedish economist Eli Heckscher and his student Bertil Ohlin. It
is also called as Factor endowments or factor proportions, or factor intensities trade theory.
This theory considered two factors of production, labor and capital. They states that a country
will specialize in the production and export of the goods whose production requires a relatively
large amount of the factor with which the country is relatively well endowed with capital only if
the ratio of capital to other factors is higher than in other countries.

Assume that:-

1) In country A
Supply of Labor = 25 units
Supply of Capital = 20 units
Capital/labor ratio = 0.8

2) In country B
Supply of Labor = 12 units
Supply of Capital = 15 units
Capital/labor ratio = 1.25

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In the above example, even though Country A has more capital in absolute terms, Country B is
more richly endowed with capital because the ratio of capital to labor in Country A (0.8) is lower
than in Country B (1.25).
Therefore, Country A is classified as a relatively labor-intensive product and Country B is
relatively capital intensive.

The Heckscher Ohlin theory says that two countries trade goods with each other if the
following assumptions hold:-
 The factors of production are in different proportion in both countries.
 The goods produced require more capital or more labour.
 Capital and Labour do not have to move between the two countries.
 No cost with goods transporting between the countries.
 The citizens of the trading countries must have the same needs.
 No obstructions to trade (for e.g. trade controls, transport costs) are there.
 Both commodity and factor markets are perfectly competitive.
 There are constant or decreasing returns to scale.

Product Life Cycle Theory: -

The product life-cycle theory is an economic theory that was developed by Raymond Vernon in
response to the failure of the Heckscher-Ohlin model to explain the observed pattern of
international trade. The theory suggests that early in a product's life-cycle all the parts and labor
associated with that product come from the area in which it was invented. After the product
becomes adopted and used in the world markets, production gradually moves away from the
point of origin. In some situations, the product becomes an item that is imported by its original
country of invention. A commonly used example of this is the invention, growth and production
of the personal computer with respect to the United States.
The model applies to labor-saving and capital-using products that (at least at first) cater to high-
income groups.
The model demonstrates dynamic comparative advantage. The country that has the comparative
advantage in the production of the product changes from the innovating (developed) country to
the developing countries.

The Stages of Product Life Cycle Theory:-

There are five main stages of Product Life Cycle Theory which are as follows:-

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Stage 1: Introduction:-
New products are introduced to meet local (i.e., national) needs, and new products are first
exported to similar countries, countries with similar needs, preferences, and incomes. If we also
presume similar evolutionary patterns for all countries, then products are introduced in the most
advanced nations. (E.g., the IBM PCs were produced in the US and spread quickly throughout
the industrialized countries.)

Stage 2: Growth:-
A copy product is produced elsewhere and introduced in the home country (and elsewhere) to
capture growth in the home market. This moves production to other countries, usually on the
basis of cost of production. (E.g., the clones of the early IBM PCs were not produced in the US.)
The Period till the Maturity Stage is known as the Saturation Period.

Stage 3: Maturity:-
The industry contracts and concentrates—the lowest cost producer wins here. (E.g., the many
clones of the PC are made almost entirely in lowest cost locations.)

Stage 4: Saturation:-
This is a period of stability. The sales of the product reach the peak and there is no further
possibility to increase it. This stage is characterized by:-
 Saturation of sales (at the early part of this stage sales remain stable then it starts falling).
 It continues till substitutes enter into the market.
 Marketer must try to develop new and alternative uses of product.

Stage 5: Decline:-
Poor countries constitute the only markets for the product. Therefore almost all declining
products are produced in developing countries. (E.g., PCs are a very poor example here, mainly
because there is weak demand for computers in developing countries. A better example is
textiles.)
Note that a particular firm or industry (in a country) stays in a market by adapting what they
make and sell, i.e., by riding the waves. For example, approximately 80% of the revenues of H-P
are from products they did not sell five years ago. The profits go back to the host old country.

International Monetary System: Meaning

International Monetary System (IMS) is a well-designed system that regulates the valuations and
exchange of money across countries. It is a well-governed system looking after the cross-border
payments, exchange rates, and mobility of capital. This system has rules and regulations which
help in computing the exchange rate and terms of international payments. In other words,
International Monetary System mobilizes the capital from one nation to another by felicitating

16
trade. There are many participants like MNCs (Multinational Corporations), Investors, Financial
Institutions, etc in the International Monetary System.

The main purpose of the International Monetary System today is, to enhance high growth in the
world with stable price levels. Earlier the scope was only up to exchange rates, now the system
has a broader scope by taking financial stability into consideration. International Monetary
System has established International Monetary Fund (IMF) and the World Bank in the year
1944.

International Monetary System is also known as “International Monetary and Financial System”
and also “International Financial Architecture”.

Evolution of International Monetary System

Over the past 75 years, the International Monetary System has modified according to the
prevailing conditions. The scope has evolved over the years, but the purpose of the system has
remained constant. The evolution of the International Financial Architecture is as follows:-

Classic Gold Standard

The first phase of the International Monetary System was the Classic Gold Standard from 1816
to 1914. In the initial years of the Gold Standard, only a few countries adopted this standard.
Later almost all countries accepted it. Usually, coins and billions of gold were useful during this
standard. This gold standard gave birth to a fixed exchange rate system with minimal
fluctuations. Because of the most fixed exchange rate, International trade saw a boost during this
time. Gold Standard also made all countries of the world abide by strict monetary policy. This
standard was helpful in correcting trade imbalances in the country. The other name of Classic
Gold Standard is International Gold Standard.

Why Classic Gold Standard Collapsed?

After the end of World War 1, the Classic Gold Standard collapsed. During World War, many
countries printed more money in order to finance their military requirements. As a result of this,
the money in circulation exceeded the gold reserves of the country and so, those countries have
to give up on Classic Gold Standard. The only United States of America didn’t give up on
Classic Gold Standards.

Interwar Period

17
The period between World War 1 and World War 2 is known as the Interwar Period. This was
the next episode of the International Monetary System from 1915 to 1944. During this time,
Britain was replaced by the United States of America as the dominant financial powerhouse
across the globe. During this period, all the economies had gone into a depression with a higher
inflation rate. The fixed exchange rate system collapsed with a higher supply of money. Almost
all countries started focussing on domestic revamping and not on international trade.

Bretton Woods System

The period after World War 2, gave birth to Bretton Woods System. This monetary system was
in existence from 1945 to 1972. Representatives from 44 countries, in the year 1944 met at
Bretton Woods of United States and came up with a new International Monetary System. The
focus of the Bretton Woods Agreement was to establish a uniform and liberal International
Financial Architecture, with independence on domestic policies. This agreement gave birth to the
US Dollar-based Monetary System or Gold-Exchange Standard. This system gave birth to the
pegging of domestic currency in terms of US Dollars. A price of $35 was set for 1 ounce of gold.
The countries rather than linking their currency to the gold-linked it to US Dollars.

All the member countries of Bretton Woods had to maintain their currencies value within 1%
upward or downward variations in comparison to Fixed Exchange Rate. This agreement also
allowed the Governments of the country to convert their gold into the US Dollar, at any point in
time. Eventually, countries and businesses have started ignoring the link between US Dollar and
Gold, and have started considering exchange rates directly.

If the situation prevailed then Bretton Woods Agreement allowed the country to devalue its
currency by more than 10% straight. Although, it didn’t allow countries to use this mechanism to
benefit from imports and exports of the country.

Downfall of the Bretton Woods System

Post-World War situation, the supply of US Dollars suddenly increased in the world economy.
As a result of it, many countries started questioning the quantum of gold reserves of the US
Government with the supply of the US Dollar. By 1973, many countries started losing
confidence in the US Dollar and started searching for some other reliable source.

Current International Monetary System

After the downfall of the Bretton Woods System, there has not been any formal International
Monetary System in place. The present-day International Financial Architecture is a managed

18
float system. All the currencies of all the countries can freely float against one another in an open
market under the managed float system. The government intervenes only when the currency
needs to be stabilized. Managed Float System is in place since 1976 with the Jamaica
Agreement. Later in 1980, the International Financial Architecture was regulated by G-5
countries. This G-5 group has currently turned into G-20, with a group of 20 countries managing
the exchange rate on managed float system.

19
Advantages of Current International Monetary System
Following are a few advantages of the International Monetary Market

 IMS enhances financial stability and maintains the price level on a global scale. It also
boosts global growth.
 International Monetary System mobilizes money across countries and determines the
exchange rate.
 This system encourages the governments of respective countries to manage their Balance
of Payment by reducing the trade deficit.
 IMS is a well-regulated system that makes the whole process of international trading
smooth.
 This system relocates the capital from one country to another by enhancing cross-border
investments.
 International Financial Architecture provides liquidity to the countries of the world.
 This system tries and avoids any short or long-run disruptions in the world economy.
These advantages are non-exhaustive in nature.

Criticisms of Current International Monetary System

The biggest criticism of the present International Monetary System is that it is incompetent in
avoiding global financial crises. There have been four serious financial crises over the past few
years. Mexico in the years 1994 and 1995 has suffered from major economic and financial
downfall. These crises came to an end in December 1996. Similarly in the year 1997, Southeast
Asia had suffered from a major economic breakdown. Russia and Brazil also had to go through
serious financial crises in the year 1998 and 1999 respectively. In 2007-2009, the Global
Economic Crisis questioned the current International Financial Architecture. There have been
many such major financial breakdowns over the past few years, which the International Financial
Architecture was unable to avoid.

The second criticism with respect to the current International Financial Architecture is that
sometimes the exchange rate remains misaligned. Managed Float System, sometimes gets
misaligned due to either internal or external factors.

Foreign Exchange Market:-

The foreign exchange market is the place where money denominated in one currency is
bought and sold with money denominated in another currency. In simple words, it is place
where foreign currencies are exchanged (bought & sold).

20
Foreign exchange also refers to the global market where currencies are traded virtually around-
the-clock. The term foreign exchange is usually abbreviated as "forex" and occasionally as "FX."
Any currency other than the local currency which is used in settling international transactions
also called foreign currency. Or any System of trading and converting the currency of one
country into that of another also known as foreign exchange market.

Foreign exchange refers to the process or mechanism by which the currency of one country is
converted into the currency of another country and thereby involves the international transfer of
money. It is the means and method by which rights to wealth in a country’s currency are
converted into rights to wealth in another country’s currency. In banks when we talk of foreign
exchange, we refer to the general mechanism by which a bank converts currency of one country
into that of another. Foreign trade gives rise to foreign exchange. Foreign trade is transacted
either in the currency of the exporter’s country or that of the importer’s country, or that of a third
country acceptable to both the exporter and the importer.

For instance, if US firm import goods from a British company, US dollar needs to be converted
into sterling. This conversion from one currency into another is typical of the transactions that
take place in the foreign exchange market.
Or
If 1 US $ is exchanged for Rs. 45 then foreign exchange rate is 1 US $ = Rs. 45.
In other words, it is the value or price of a country’s currency expressed in terms of a foreign
currency.
In India, the major foreign exchange markets are situated in Mumbai, Calcutta, Chennai, and
Delhi.

Narrow Meaning:-
In the narrow sense, foreign exchange simply means the money of a foreign country. Thus,
American dollars are foreign exchange to an Indian and Indian rupees arc foreign exchange to an
American. In practice, foreign exchange is often used to refer to a country's actual stock of
foreign currency, i.e., foreign currency notes or the means of obtaining such money through
traveler’s cheques or letters of credit.

Broad Meaning:-
In the broader sense, the foreign exchange is related to the mechanism of foreign payments. It
refers to the system whereby one currency is exchanged for or converted into another. Foreign
exchange market is a market where foreign currencies are bought and sold by the traders' to meet
their obligations abroad.

According to Encyclopedia Britannica, "Foreign exchange is the system by which commercial

nations discharge their debts to each other."

21
 In the words of Hartly Wethers, "Foreign exchange is the art and science of international
monetary exchange."
According to Paul Einzig, “Foreign exchange is the system or process of converting one
national currency into another and of transferring the ownership of money from one country to
another.”

Need for Conversion:-

1. Any country, developed or developing, has to reach out beyond its barriers and boundaries to
trade with other countries. The currency of each country is a legal tender only within its
national boundaries.
2. When countries trade there is no single universal currency in which the settlement can be
made. The payment has to be effected either in the currency of the buyer or the seller or in a
mutually accepted third currency. This necessitates the conversion of one currency into
another.

Foreign Exchange Market:-

The Foreign exchange or the Forex market facilitates the participants to obtain, trade, exchange
and speculate foreign currency. The foreign exchange market consists of banks, central banks,
commercial companies, hedge funds, investment management firms and retail foreign exchange
brokers and investors. It is considered to be the leading financial market in the world. It is vital to
realize that the foreign exchange is not a single exchange, but is created from a global network of
computers that connects the participants from all over the world.
The foreign exchange market is immense in size and survives to serve a number of functions
ranging from the funding of cross-border investment, loans, trade in goods, and trade in services
and currency speculation. The participant in a foreign exchange market will normally ask for a
price.

Forms of Foreign Exchange Market:-The trading in the foreign exchange market may take
place in the following forms:-
 Outright cash or ready – Foreign exchange currency deals that take place on the date of the
deal.
 Next day - Foreign exchange currency deals that take place on the next working day.
 Swap – Simultaneous sale and purchase of identical amounts of currency for different
maturities.
The most common type of forward transaction is the swap. In a swap, two parties exchange
currencies for a certain length of time and agree to reverse the transaction at a later date.
These are not standardized contracts and are not traded through an exchange. A deposit is
often required in order to hold the position open until the transaction is completed.

22
 Future-Main article: Currency future
Futures are standardized forward contracts and are usually traded on an exchange created for
this purpose. The average contract length is roughly 3 months. Futures contracts are usually
inclusive of any interest amounts.
 Option-Main article: Foreign exchange option
A foreign exchange option (commonly shortened to just FX option) is a derivative where the
owner has the right but not the obligation to exchange money denominated in one currency
into another currency at a pre-agreed exchange rate on a specified date. The options market is
the deepest, largest and most liquid market for options of any kind in the world.
 “Spot” and “Forward” contracts - A Spot contract is a binding obligation to buy or sell a
definite amount of foreign currency at the existing or spot market rate. A forward contract is
a binding obligation to buy or sell a definite amount of foreign currency at the pre-agreed rate
of exchange, on or before a certain date.

The advantage of spot dealing has resulted in a simplest way to deal with all foreign currency
requirements. It carries the greatest risk of exchange rate fluctuations due to lack of certainty of
the rate until the deal is carried out.
The spot rate that is intended to receive will be set by current market conditions, the demand and
supply of currency being traded and the amount to be dealt. In general, a better spot rate can be
received if the amount of dealing is high. The spot deal will come to an end in two working days
after the deal is struck.
A forward market needs a more complex calculation. A forward rate is based on the existing spot
rate plus a premium or discounts which are determined by the interest rate connecting the two
currencies that are involved. For example, the interest rates of UK are higher than that of US and
therefore a modification is made to the spot rate to reflect the financial effect of this differential
over the period of the forward contract. The duration will be up to two years for a forward
contract. A variation in foreign exchange markets can be affected to any company whether or not
they are directly involved in the international trade or not. This is often referred to as ‘Economic’
foreign exchange and most difficult to protect a business.

Functions of Foreign Exchange Market:-

A well developed foreign exchange market is of vital importance to International Business as it
discharges three important functions:-
 Facilitates conversion of currencies.
 Provides credit for international transactions.
 Minimizes exposure to the risks of exchange rate fluctuations.

Major Foreign Exchange Instruments:-

1. Spot Market: - Spot rate [spot exchange rate] is that exchange rate which applies to those
sales/purchase transactions in foreign exchange for which payments and receipts are to be
effected on the spot. In practice, it normally means a specified short period, say two business
23
 days after the day of transaction takes place.
The most common way of stating a foreign exchange quotation is in terms of the number of units
of foreign currency needed to buy one unit of home currency.

Direct Quote: – The rate is quoted in terms of the number of units of the home currency for one
unit of the foreign currency.
Rs. 45/Dollar read as “Rs.45 per US dollar” or
1$ = Rs.51.49
Indirect Quote: – The rate is quoted in terms of the number of units of the foreign currency for
one unit of the domestic currency.
$ 0.019/Rs.1 read as “$ 0.019 per Rupee” or
Rs.1 = $ 0.019

2. Forward Market: – Forward rate [forward exchange rate] is that exchange rate which applies
to those sales/purchase transactions in foreign exchange for which payments and receipts are to
be effected on a specified future date. [Say 30, 66, 90 or 180 days].

Both the buyer & seller in the forward market agree that the forward rate will sell a stated
amount of the foreign currency at an agreed exchange rate to the buyer on a specified future date,
irrespective of the actual exchange rate that may prevail on the said future date.
For e.g. A French exporter of perfume sell perfume to a US importer with immediate delivery
but not require payment for 30 days. The US importer has an obligation to pay the required
francs in 30 days, so he or she may enter into a contract with a trader to deliver the payment in
30 days at a forward rate – the rate today for future delivery.

Factors that affect the Exchange Rates:-

All Forex trading involves the exchange of one currency with another. At any one time, the
actual exchange rate is determined by the supply and demand of the corresponding currencies.
Keep in mind that the demand of a certain currency is directly linked to the supply of another.
Likewise, when you supply a certain currency, it would mean that you have the demand for
another currency. The following factors affect the supply and demand of currencies and would
therefore influence their exchange rates.
The main factors that affect the Exchange Rates are as follows:-

1. Inflation: - If inflation in the UK is relatively lower than elsewhere, then UK exports will
become more competitive and there will be an increase in demand for Pound Sterling to buy UK
goods. Also foreign goods will be less competitive and so UK citizens will buy less import.
Therefore countries with lower inflation rates tend to see an appreciation in the value of their
currency.

24
2. Interest Rates: - If UK interest rates rise relative to elsewhere, it will become more attractive to
deposit money in the UK. You will get a better rate of return from saving in UK banks; therefore
demand for Sterling will rise. Higher interest rates cause an appreciation. This is known as “hot
money flows” and is an important short run factor in determining the value of a currency.
3. Speculation:-If speculators believe the sterling will rise in the future, they will demand more
now to be able to make a profit. This increase in demand will cause the value to rise. Therefore
movements in the exchange rate do not always reflect economic fundamentals, but are often
driven by the sentiments of the financial markets. For example, if markets see news which makes
an interest rate increase more likely, the value of the pound will probably rise in anticipation.

4. Change in Competitiveness: - If British goods become more attractive and competitive this will
also cause the value of the Exchange Rate to rise. This is important for determining the long run
value of the Pound. This is similar factor to low inflation.

5. Relative strength of other currencies:- In 2010 and 2011, the value of the Japanese Yen and
Swiss Franc rose because markets were worried about all the other major economies - US and
EU. Therefore, despite low interest rates and low growth in Japan, the Yen kept appreciating.

6. Balance of Payments:-A deficit on the current account means that the value of imports (of
goods and services) is greater than the value of exports. If this is financed by a surplus on the
financial / capital account then this is ok. But a country, who struggles to attract enough capital
inflows to finance a current account deficit, will see depreciation in the currency. (For example
current account deficit in US of 7% of GDP was one reason for depreciation of dollar in 2006-
07).

7. Government Debt: - Under some circumstances, the value of government debt can influence the
exchange rate. If markets fear a government may default on its debt, then investors will sell their
bonds causing a fall in the value of the exchange rate. For example, Iceland debt problems in
2008 caused a rapid fall in the value of the Icelandic currency. For example, if markets feared the
US would default on its debt, foreign investors would sell their holdings of US bonds. This
would cause a fall in the value of the dollar.

8. Monetary Policy:-When a central bank believes that intervention in the forex market is effective
and the results would be consistent with the government’s monetary policy, it will participate in
forex trading and influence the exchange rates. A central bank generally participates by buying
or selling the domestic currency so as to stabilize it at a level that it deems realistic and ideal.
Judgment on the possible impact of government’s monetary policy and prediction on future
policy by other market players will affect the exchange rates as well.

9. Political Situation:-Growing global tension will result in instability in the forex market.
Irregular inflow or outflow of currencies may result in significant fluctuations in exchange
25
 [Link] stability of a foreign currency are closely related to the political situation of that place.
In general, the more stable the country is, the more stable its currency will be.
We will illustrate how political factors influence exchange rates with some actual examples. At
the end of 1987, the US Dollar was suffering from continuous depreciation. In order to stabilize
the US Dollar, the G7 Finance Ministers and central bank governors released a joint statement on
23 December 1987 announcing plans for a large-scale intervention in the forex market. On 4
January 1988, the group started to dump Japanese Yen and Deutsche Mark in huge volumes
while buying US Dollars. This resulted in a rebound of the US Dollar and maintained its
exchange rate at a stable level.
10. Balance of Payments:-Balance of payments of a country will cause the exchange rate of its
domestic currency to fluctuate. The balance of payments is a summary of all economic and
financial transactions between the country and the rest of the world. It reflects the country’s
international economic standing and influences its macroeconomic and microeconomic
operations. The balance of payments can affect the supply and demand for foreign currencies as
well as their exchange rates.

The International Monetary Fund (IMF)

IMF is an International Monetary organization. It was established on December 27, 1945 in
Washington on the recommendations of Bretton Woods Conference. But it started its operations
on March 1, 1947. At present, the number of member countries of the IMF is 18.

It is a an international organization that oversees the global financial system by following the
macroeconomic policies of its member countries, in particular those with an impact on exchange
rates and the balance of payments.
It is an organization formed to stabilize international exchange rates and facilitate development.
It also offers financial and technical assistance to its members, making it an international lender
of last resort. Its headquarters are located in Washington, D.C., USA.

The IMF describes itself as- “an organization of 185 countries (Montenegro being the
185th, as of January 18, 2007), working to foster global monetary cooperation, secure
financial stability, facilitate international trade, promote high employment and sustainable
economic growth, and reduce poverty.”

Who makes decisions at the IMF?

IMF is controlled and managed by a Board of Governors. The Board of Governors, in which all
member countries are represented, is the highest authority governing the IMF. It usually meets
once a year, at the Annual Meetings of the IMF and the World Bank. Each member country
appoints a Governor–usually the country’s minister of Finance or the Governor of the Central
Bank–and an Alternate Governor who can casts his vote in the absence of Governor. The Board
of Governors decides on major policy issues but has delegated day-to-day decision making to the

26
Executive Board which consists of 24 Executive Directors, with the Managing Director as
Chairman. This Board meets three times a week, in full-day sessions.

Each Governor is allotted a number of votes, which is determined by the quota allotted to the
respective country in the capital of IMF. Each Governor has got the right of 250 votes on the
basis of the membership and one additional vote for each SDR (Special Drawing Rights)
1,00,000 of quota. The addition of these two types of votes becomes the actual voting right of the
member country. For example, India’s voting right is 250+30555 = 30805 because India’s quota
is SDR 30555 lakh. It clearly indicates that the voting right depends on the quantum of the quota
of a particular country with IMF. That’s why the rich & industrialized countries got the higher
voting right due to their higher quotas with the IMF.

Where does the IMF get its money?

The IMF’s resources come mainly from the quota (or capital) subscriptions that countries pay
when they join the IMF, or following periodic reviews in which quotas are increased. A member
is generally required to pay about 25 % of its quota in SDRs or in currencies of other members
selected by the IMF; it pays the remainder in its own currency. Quotas determine not only a
country’s subscription payments, but also the amount of financing that it can receive from the
IMF, and its share in SDR allocations.

What is SDR?
The SDR, or Special Drawing right, is an International reserve asset introduced by the IMF in
1969. Special drawing rights (XDR or SDR) are supplementary foreign exchange reserve assets
defined and maintained by the International Monetary Fund (IMF). The XDR is not a currency
per se, it instead represents a claim to currency held by IMF member countries for which they
may be exchanged. As they can only be exchanged for Euro, Japanese yen, pounds sterling, or
U.S. dollars, XDRs may actually represent a potential claim on IMF member countries' nongold
foreign exchange reserves, which are usually held in those currencies. While they may appear to
have a far more important part to play or, perhaps, an important future role, being the unit of
account for the IMF has long been the main function of the XDR.
Till 1971, all the amounts of quotas and the assistance provided were denominated in US dollar,
but since 1971, all the quotas and transactions of IMF are expressed in SDR, which is also
known as Paper Gold.

Main Objectives of IMF

The main objectives of International Monetary Fund are as follows:
1. To promote International monetary cooperation that provides machinery for consultation and
collaboration on international monetary problems.
2. To facilitate the expansion of balanced growth of international trade, and therefore
employment and income.
3. To stabilize exchange rates and to avoid competitive devaluations.
27
4. Elimination of foreign exchange restrictions, which hamper the economic growth.
5. To provide loans to help cover shortfalls in Balance of Payments (BOP) to help correct BOP
problems without hurting national or international interests.
6. To reduce restrictions on payments for trade.

Functions of IMF
The main functions of International Monetary Fund are as follows:-
1. To promote the international monetary cooperation through a permanent institution. This can
provide the machinery for consultation and collaboration in the international monetary
problems.
2. To facilitate the expansion and balanced growth, of international trade and to contribute
promotion and maintenance of high levels of employment and real income and to the
development of the productive resources of all members.
3. To promote exchange stability, to maintain orderly exchange arrangements among members,
and to avoid competitive exchange, depreciation.
4. To assist in the establishment of a multilateral system of payments in respect of current
transactions between members and in the elimination of foreign exchange restrictions.
5. To give confidence to members by making the general resources of the fund temporarily
available to them under adequate safeguards thus, providing them with opportunity to correct
adjustment in their balance of payments without resorting to measures destructive to national
or international prosperity.

International Bank for Reconstruction and Development (IBRD-World Bank)

The International Bank for Reconstruction and Development also known as the World Bank is an
outcome of the Bretton-woods conference of 1944. Its head office is situated in Washington,
DC, with offices in more than 100 countries. Its main function is to provide long term capital
assistance to its member countries for their reconstruction and development. Initially IBRD
concentrated on reconstruction of the war shattered European economies. Later bank shifted its
focus and development of the backward countries began to receive prime importance.

Mission statement of IBRD

A. World free of poverty.
 To fight poverty with passion and professionalism for lasting results.
 To help people help themselves and their environment by providing resources, sharing
knowledge, building capacity, and forging partnerships in the public and private sectors.
 To be an excellent institution able to attract, excite, and nurture diverse and committed
staff with exceptional skills who know how to listen and learn.
B. Principles.

28
 Client centered, working in partnership, accountable for quality results, dedicated to financial
integrity and cost effectiveness, inspired and motivated.
C. Values.
Personal honesty, integrity, commitment, working together in teams with openness and trust,
empowering others and respecting differences, encouraging risk-taking and responsibility,
enjoying our work and our families.

Functions of IBRD:
The main functions of the bank are:
1. To assist in reconstruction and development of the territories of its member governments by
facilitating investment of capital for productive purposes Cynical;
2. To promote foreign private investment by guarantees of or through participation in loans and
other investments of capital for productive purposes;
3. Where private capital is not available on reasonable terms, to make the loans for productive
purposes out of its own resources or out of the funds borrowed by it; and
4. To promote the long range growth of international trade and the maintenance of the
equilibrium in the balance of payments of members by encouraging international investments
for the development of the productive resources of members.

The bank has adopted as its principle objective lending for productive projects which will lead to
economic growth in its less developed member countries.

Organisation of IBRD
IBRD is an intergovernmental organization. Only Governments of various countries can become
its members. As of June, 2001, total 184 Countries are member of the IBRD. The management
of the bank is on the same lines as that of I. M. F., with the board of governors, Executive
directors and a president. The IBRD has 22 executive directors of which 5 are nominated by the
five biggest shareholders, Namely, USA, UK, Germany, Japan and France. Remaining directors
are responsible for general operations of the bank and meet every month. The president of the
bank (currently, James D. Wolfensohn) acts the chairman of the board of directors. The ultimate
authority is the board of governors in which all member states are represented. The voting rights
of the governors and executive directors are proportionate to the share capital of the member
country which they represent. Therefore, the policies of the bank tend to get influenced by the
opinion means of the largest shareholders.

Resources of IBRD
Resource of the bank consists of the capital and borrowings. Initially the authorized capital of
the IBRD was US $ 10,000 million divided into 1,00,000 Shares of US $ 1,00,000 each.
Share Capital
a) 2% is payable by the member country in gold or US dollars. This portion is freely available
for lending;
29
b) 18% is payable in member’s own currency. This portion is available for lending with the
consent of the member whose currency is involved; and
c) 80% is kept in reserve to be paid by the member when called.

Thus only 20% of each member’s subscription Is available to the bank for lending activities.
The balance 80% serves as a guarantee-resource for bank’s borrowings operations in
international markets.

Borrowings
IBRD raises money for its development financing programs from the world’s capital markets.
IBRD sells AAA rated bonds and other debt securities to pension funds, insurance companies,
corporations, other banks and individuals across the globe. Further IBRD also receives
contributions from wealthy nations for its various development programs.

Major activities of IBRD.

1. Lending activities

The bank grants or facilitates loans in any of the following ways.

1) Lending from its own funds, by either granting loan or participating in the project;
2) Lending from resources raised in the market of a member, or otherwise either by granting
loan or participating in the project; and
3) By guaranteeing in whole or in part loans made by private investors through the usual
investment channels.

The bank grants loans for productive purposes like agriculture and rural Development, power,
industry, transport, poverty eradication and education programs, etc.
The interest rate charged by the bank is the estimated cost to the bank of borrowing Money for
comparable term in the market and is uniform without distinction been made among borrowers.
In addition to interest, commission of 1% For the purpose of creating a special reserve against
loss and 0.5% for administrative expenses are charged.
In guaranteeing loans, the bank acts as a bridge between the donors and the recipients of foreign
aid for development. The bank, continuously assess the creditworthiness of the recipients of aid
and convinces the foreign investors that the political and economic climate for investment is
favorable. Its coordinates aid giving activities of the western countries. IBRD has organized
consortium for centralizing the flow of foreign aid so that the recipients of aid to not play one aid
giver against the other.
IBRD also helps developing countries to identify appropriate projects for development which can
be financed by the world investors.

Bank’s Policy regarding loans and Guarantees

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The bank adopts the following policies for lending and tendering guarantees
1. All loans are made to governments or they must be guaranteed by governments.
2. Repayment is to be made within 10 to 35 years.
3. Loans are made only in circumstances in which other sources are not readily available.
4. Investigations are made of the probability of repayment, considering both the soundness of
the project and the financial responsibility of the government.
5. Sufficient surveillance is maintained by the bank over the carrying out of the project to
ensure that it is relatively well executed and managed.
6. Loans are sanctioned on economic and not political considerations.
7. The loan is meant to finance the foreign exchange requirements of specific projects, normally
the borrowing country should mobilize its domestic resources.

Since Bank has to finance high priority productive sectors of economies and it to mind
creditworthiness of the borrowers, bank conducts detailed studies through its Missions and
resident representatives of the economy of the recipients of the aid. The headquarters of the bank
acts as a monitoring center of the economies of the borrowing countries, As it conducts
comprehensive and limited pre-investment surveys financed either by the bank or the UNDP.
The bank’s dependence for resources on capital markets of the world influences its economic and
social philosophy which is based on the doctrine of ‘free enterprise’.

2. Technical assistance & other social activities

In addition to financing and guaranteeing development projects of poor and less developed
economies, bank also provides technical assistance in the form of Surveys, Conducting training
and skills development programs, etc for the borrowing countries.
In September, 2000 bank launched the Multi country HIV / AIDS Program (MAP) for Africa.
Under the MAP, Flexible and rapid funding will be committed at concessional terms to HIV /
AIDS eradication Programs developed by borrowing nations.
On the Poverty reduction front, the bank’s World Development Report 2000-2001 emphasized
opportunity, empowerment, and security as keys to reducing Multidimensional Poverty. Banks
support for education is emphasizing access, quality and Equity; Bank is emphasizing reforms in
the areas law and justice, Environmental protection programs, up-liftment of poor women’s
Programs, etc.

International Finance Corporation (IFC)

 IFC is the largest global development institution focused exclusively on the private sector
in developing countries. The Bank Group has set two goals for the world to achieve by
2030: end extreme poverty and promote shared prosperity in every country.

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 It is a private-sector arm of the World Bank Group, to advance economic development
by investing in for-profit and commercial projects for poverty reduction and promoting
development.
 IFC is also a leading mobilizer of third-party resources for projects.
 Governance of IFC
o IFC Boards of Governors: The Boards of Governors consist of one Governor and one
Alternate Governor appointed by each member country. The office is usually held by
the country's minister of finance, governor of its central bank. The Board of Governors
delegates most of its authority over daily to the Board of Directors.
o IFC Board of Directors: The Board of Directors consists of executive directors and is
chaired by the President of the World Bank Group. Executive Directors are appointed
or elected by the Governors. Voting power on issues brought before them is weighted
according to the share capital each director represents. The directors meet regularly to
review and decide on investments and provide overall strategic guidance to IFC
management.
 IFC raises virtually all funds for lending activities through the issuance of debt obligations
in international capital markets. Our borrowings are diversified by country, currency,
source, and maturity in order to provide flexibility and cost-effectiveness.
 Since first being rated in 1989, IFC has been rated triple-A every year by Standard and
Poor's and by Moody's. Our high credit rating is essential for maintaining our ability to
access markets globally and to maintain our low cost of funding.
 IFC makes loans to businesses and private projects generally with maturities of seven to
twelve years. It determines a suitable repayment schedule and grace period for each loan
individually to meet borrowers' currency and cash flow requirements. It may provide
longer-term loans or extend grace periods if a project is deemed to warrant it.
 It does not have a policy of uniform interest rates for its investments. The interest rate
is to be negotiated in each case in the light of all relevant factors, including the risks
involved and any right to participation in profits, etc.
 Through its Global Trade Finance Program, the IFC guarantees trade payment
obligations of more than 200 approved banks in over 80 countries to mitigate risk for
international transactions. The Global Trade Finance Program provides guarantees to
cover payment risks for emerging market banks regarding promissory notes, bills of
exchange, letters of credit, bid and performance bonds, supplier credit for capital goods
imports, and advance payments.

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 IFC attempts to guide businesses toward more sustainable practices particularly with
regards to having good governance, supporting women in business, and proactively
combating climate change.

International Development Association (IDA)

 IDA is the part of the World Bank that helps the world’s poorest countries. Overseen by
173 shareholder nations, IDA aims to reduce poverty by providing loans (called “credits”)
and grants for programs that boost economic growth, reduce inequalities, and improve
people’s living conditions.
 IDA is one of the largest sources of assistance for the world’s 75 poorest countries, 39 of
which are in Africa, and is the single largest source of donor funds for basic social services
in these countries.
 IDA supports a range of development activities that pave the way toward equality,
economic growth, job creation, higher incomes, and better living conditions. IDA's
work covers primary education, basic health services, clean water and sanitation,
agriculture, business climate improvements, infrastructure, and institutional reforms.
 Governance of IDA:
o IDA Boards of Governors: The Boards of Governors consist of one Governor and one
Alternate Governor appointed by each member country. The office is usually held by
the country's minister of finance, governor of its central bank. The Board of Governors
delegates most of its authority over daily matters such as lending and operations to the
Board of Directors.
o IDA Board of Directors: The Board of Directors consists of executive directors and is
chaired by the President of the World Bank Group. Executive Directors are appointed
or elected by the Governors.
 IDA lends money on concessional terms. This means that IDA credits have a zero or very
low-interest charge and repayments are stretched over 30 to 38 years, including a 5- to 10-
year grace period. IDA also provides grants to countries at risk of debt distress.
 To borrow from the IDA's concessional lending programs, a country's gross national
income (GNI) per capita must not exceed $ 1,145 (the fiscal year 2019).
 IDA also provides significant levels of debt relief through the Heavily Indebted Poor
Countries (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI).

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