International Finance

Many firms in India, however borrow foreign currency loans, and invest abroad. International involvement of Indian firms is increasing and this trend is expected to continue as India forges stronger linkages within world economy.

While the principles of finance discussed in are equally applicable to a firm with international linkages as a manager in such a firm, you need to understand certain special features of international finance. Multiple currencies, euro-markets, different tax regimes, and barriers to financial flows are the distinguishing features of international finance.

The field of international finance has witnessed explosive growth and dynamics changes in recent decades. This has been stimulated by a variety of forces: (1) The change in the international monetary system from a fairly predictable system of exchange to a flexible ad volatile system of exchange, (2) Emergence of new institutions and markets and a greater need for international financial intermediation (3) A greater integration of the global financial system.

Basic of international finance is organized into eight sections as follows:

1. World monetary system
2. Foreign exchange market
3. Raising foreign currency finance
4. International capital budgeting
5. Financing and insuring exports
6. Documents in international trade
7. Foreign exchange exposure
8. Management of foreign exchange exposure

World Monetary System:

In order to understand the present world monetary system, it is helpful to look at the developments during the last few decades. From the end of the Second World War until February 1973, the adjustable peg exchange rate system, administered by the international Monetary Fund, prevailed. Under this system the US dollar which was linked to gold ($35 per ounce) served as the anchor currency. Other currencies were expressed in terms of the dollar and through this standard, exchange rates between currencies were established A special feature of this system was that close control was exercised over the exchange rates between various currencies and the dollar –a fluctuation of ±1 per cent was allowed around the fixed exchange rate.

What mechanism was used to hold fluctuations within the one per cent limit? Central banks of various countries participated actively in the exchange market to limit fluctuation. For example, when the pound sterling would fall vis-à-vis other currencies due to forces of demand and supply in the international money and capital markets, the bank of England would step in to buy pound sterling and offer gold or foreign currencies in exchange. When the pound sterling tended to rise, the Bank of England would sell it.

What happened when the central bank of a country found it extremely difficult to maintain the exchange rate within limits? If any country experienced continued difficulty in preventing the fall of its exchange rate below the lower limit, it could, with the approval of the International Monetary Fund, devalue its currency. India for example, devalued its currency in 1966 in a bid to cope up its balance of payments problem. A country enjoying continued favorable balance of payments situation would find it difficult to prevent its exchange rate from rising above the upper limit. Such a country would be allowed, again with the approval of the International Monetary Fund, to revalue its currency. West Germany for example was allowed to revalue its currency in 1969.

Present System of Floating:

In 1973, the US dollar was de-linked with gold. Put differently, it was allowed to float. This brought about a dramatic change in the international monetary system. The system of fixed exchange rates where devaluations and revaluation occurred only very rarely gave way to a system of floating exchange rates.

There are basically two types of floating rates: (1) free floating rates, and (2) managed floating rates. The developed countries (like the US, Japan, Britain and so on). In general permit their currencies to float freely. The exchange rates for the currencies of these countries are determined by the forces of demand and supply in the foreign exchange market. Put differently their currencies find own levels without government intervention.

The developing countries on the other hand, try to manage the exchange rates of their currencies to some extent. Essentially they sallow their currencies to fluctuate freely within certain bounds which are periodically revised. The purpose of such intervention is to avoid volatile fluctuations which may be de-stablising.