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Global Financial Structure The Global Financial Structure, a fixed system of exchange rates based on individual countries making adjustments of imbalances without resorting to devaluations or currency regulations, was in operation for two and a half decades after the Second World War. It was formulated on the basis of the Breton Woods Agreement - the instrument through which the International Monetary Fund (IMF) was also conceived. When a country joined the IMF, its currency's value was declared based on gold or the dollar. This value then became the basis on which a country regulated its trade against the currencies of the world. Given the strength of the US dollar, the dollar was the basis of world trading currency, with countries trading against it. The dollar was hinged to the price of gold. However, as the objective of the agreement was that currencies were to be converted into gold on demand, at least for settlement between central banks, and since the USA was the only country that maintained physical gold convertibility, this arrangement did not work satisfactorily. What emerged was another arrangement by which individual countries caused their currencies to float or remain pegged to currency values of other countries. Thus a floating exchange rate system replaced the Breton Woods system, forming the basis oi the current international financial framework.'' Balance of Payments The balance of payments is a system of accounts designed to show how a nation finances its international activities and what role the nation plays in the world economy. The focal point of the balance of payments is the external liquidity of a nation which determines the nation's ability to meet claims from the outside world and to acquire the goods and services it needs to import. The balance of payments of a nation comprises all international transactions carried out by a nation and its various constituents, viz. the government, business, private residents, etc., and is usually computed, reviewed and analyzed at periodic intervals which may be monthly, quarterly or annually. The purpose of maintaining and analyzing the balance of payments is essentially to find out whether the country has a debit or a credit balance of payments, i.e. whether the inflow of its foreign exchange exceeds or is less than its .outflow. While the balance of payments' primary purpose is to answer questions pertaining to a country's international financial position, it also serves as a framework for analyzing and interpreting a wide range of problems dealing with the economic and business life of a country. Each country tries to maintain a surplus balance of payments and hence have a greater inflow of foreign exchange by various means such as exports, sales of goods, receipt of foreign investments, etc. A healthy surplus of balance of payments enables a country w have a stable, strong currency and a sound domestic economy with inflation and interest rates under control. However, an excessive surplus of balance of payments can result in various other problems. Exports automatically tend to become weaker. Countries that have excessively strong balance of payments such as Japan can adversely affect the economy oat another country such as USA, resulting in counter-protectionist measures. Countries, such as Mexico, on the other hand, are classic examples on the other end of the spectrum. Mexico chose the route of rapid economic development, using its oil wealth and the boom in oil prices as a base. Its borrowings however, were enormous and its ability to generate surpluses on international borrowings inadequate. Debts therefore accumulated, resulting in a debt crisis of massive proportions and throwing several American and European banks out of business. The crisis was mitigated gradually by a variety of means mainly by the writing off, deferring and reduction of debt by both banks and governments. In the case of the Brazilian economy, better fiscal management has managed to slow down on external foreign exchange commitments, while accelerating internal generation of revenue, thus effecting a pull out of the debt crisis. Governments often correct balance of payments differences through legislative action, effecting trade and capital flows, correcting internal imbalances in the revenue spending of governments, and changing exchange rates by devaluation or revaluation. Business decisions, such as making investments or holding deposits in certain currencies, can in turn affect the balance of payments of a country, thus affecting the value of its currency. Direct investments can take place in various ways. For instance, they could take the form of direct foreign exchange investments in the host country to acquire assets such as land, labor, capital and technology. If imports are involved here, a dollar payment is again effected. Then again the firm's products may be exported and the raw materials required may be imported. The net effect, in terms of balance of payments of foreign exchange, could be positive or negative depending on how the investments are made and the nature of the business and how it is serviced - domestically or overseas. Foreign Exchange Markets and Exchange Rates The mechanism which facilitates the purchase and sale of commodities and securities from one nation to another is known as the foreign exchange market. This mechanism generally operates through the international departments of large commercial banks. There are about 100 currencies in the world. However, major trade is carried out in US dollars, pound sterling, Japanese yen, Swiss francs and German marks. The supply of foreign exchange is provided by those who are willing to sell a currency they hold, including foreign currency received against export of goods and services, sale of securities to foreign nationals and receipt of gifts or contributions made by foreign nationals. The rate of exchange is defined as the number of units of one currency exchanged against one unit of a currency of another country. In other words, it is the price one pays in one's home currency to purchase funds or material from another country. The rate of exchange is the link connecting different national currencies, making global cost and price comparison possible. Currently exchange rates are much more volatile than they were a decade ago. Global companies attempt to neutralize the impact of exchange rates by-matching cost to revenue and by strengthening its currency in all regions so that a negative in one region is offset by a positive pip the other. The easier it is to exchange one currency for another, the higher the 'degree of convertibility of that currency. Very few countries in the world have full convertibility as various restrictions are applied to regulate currency transfers depending on requirements for the import of certain kinds of goods, travel, etc. on a selective basis. Foreign exchange is transacted in two ways: spot and forward. Spot exchange involves the purchase and sale of a foreign currency for immediate delivery and paid for upon delivery. Immediate here usually means two working days. Forward exchange covers transactions where currencies are bought or sold now for future delivery. The main feature of the forward exchange market is Thai the payment is in the future though the exchange rate is agreed upon in the present. An interesting example of the impact of currencies on business is that of Lakers Airways. A British airline started by Sir Freddie Lakers, its fleet was financed by US dollar borrowings, as interest rates in the USA at the time were lower than in Britain. Tickets were sold in advance, denominated in pound sterling. The pound subsequently dropped approximately 20 per cent against the dollar, as US interest rates rose, and Lakers Airways with its liabilities in dollars, found itself bankrupt. What in effect had happened was that the company had moved from the air travel business to becoming a speculator in currencies. Taxation Taxation is another aspect to be considered here. The location ol an investment decision, for example, may be influenced by better tax rate, and the taxation structure itself can contribute to determining the nature of a global venture, and methods of financing such an operation. Thus a global operatton may take the form of a joint venture, a subsidiary or branches, funds may be raised internally or externally, and debt to equity ratios maintained along certain lines, all on the basis of the taxation structure. Interest rates on local borrowings and foreign borrowings, law relating to borrowings internationally and paying in foreign currencies, regulations of dividend payments and taxes on dividend are other considerations of the corporate legal structure affected by taxation Corporate Structuring and Tax Planning In the process of going global, firms need to carefully plan their international corporate structures so as to minimize the burden of taxation, taking into account the taxation laws in different locations across the world. They also need to minimize cost of setting up corporate structures, again taking advantage of various cost elements of corporate structuring in different locations. The tax and legal aspects which are taken into account while structuring the corporate affairs of a multi-national group are as follows: Corporate taxation Broadly, corporation tax in different jurisdictions follows one of two approaches, viz, the worldwide income tax concept and the territorial income tax concept. In the worldwide tax concept, corporations are liable to pay tax on worldwide income. In the territorial tax concept, corporation sin a particular jurisdiction are faxed only on income arising, received or located in that particular jurisdiction. Countries such as USA, UK, and Japan follow the Worldwide tax concept whereas countries such as Singapore, Malaysia and Hong Kong follow the territorial tax concept. Double taxation treaty network As many products are manufactured with different sources of material emanating from different nations, these may be subject to taxes from each of the nations involved. Several treaties have been made to protect the enterprise from paying tax more than once on the same product by mutual agreement between various countries. Though no multilateral treaties on double taxation have been expted as yet, the Organization for Economic Cooperation and Development (OECD) has drawn up ad raft convention which lays down guidelines for countries for the negotiation of bilateral treaties on taxation. Another model has been developed by the United Nations. Direct taxes are generally charged by countries on the basis of residence, domicile, place of incorporation, control and management, source of income, etc., and with tfie globalization of business, multiplicity of these factors may result in double taxation. Double Tax Avoidance Agreements (DTAA) are entered into between two countries to avoid/minimize double taxation and to provide equitable sharing of revenue that may legitimately be claimed by both countries. Other objectives of DTAA are to promote bilateral trade and investment and to prevent tax avoidance through the exchange of information. DTAA have an overriding effect over the domestic tax legislation of respective countries in case of conflict, and generally reduce the withholding taxes in case of dividends, interests, loyalties, fees for technical services and license fees. Use of tax havens In order to attract foreign investment and capital, certain countries are following a liberal or no tax regime policy. The countries include Hong Kong, Channel islands, Bermuda, Bahamas, British Virgin Islands, Monte Carlo, Luxembourg, Liberia, Mauritius and others. The tax havens are widely used for trusts, foundations, holding companies, investment companies, offshore funds, banking companies, rein voicing companies and captive insurance companies. Anti-tax haven laws In order to prevent the abuse of tax havens in certain cases, seven developed countries have promulgated anti-tax haven laws. The instances of anti-tax haven laws are Controlled Foreign Corporation law in UK and similar legislation in USA, Canada, West Germany, Japan and France. Anti-tax evasion measures The tax laws of various countries provide anti-tax evasion regulations for transfer pricing, arm's length test, thin-capitalization and other relevant aspects. Corporate laws and legal framework In formulating the corporate structure, the corporate laws such as company legislation, exchange control regulations, intellectual property rights regulations have to be carefully analyzed and considered. Foreign investment regulations The foreign investment policies of different countries govern the maximum permissible levels of foreign investment in different sectors, terms of foreign investment, repatriation of dividends and capital gains and the minimum level of local participation. As such, the corporate structure has to be designed in conformity with the prevalent foreign investment regulations and by instituting adequate safeguards for protection of foreign investors. Personal taxation As in the case of corporation tax, personal taxation may be levied in respect of worldwide income or territorial income. Even in countries following worldwide tax concept, there are certain special categories such as resident but not domiciled, resident but not wintrily resident which are given confessional tax treatment. There are certain countries which do not impose any tax on Personal income such as Brunei and Monte Carlo. Other factors Apart from the above, there are other factors such as business exigencies, selection of appropriate form of organization, subsidiaries and special concessions. Global Financial Management and Information Systems The MIS system of global firms should be centralized and uniform as this is one area where great local flexibility is not essential. Global companies should reckon in one major currency for global operations, such as the dollar, for uniform comparison of performances. Many firms do not realize the opportunities for taking advantage of global financial management functions and instead allow subsidiaries to operate at individual levels, then trying to coordinate and centralize the effort. It is important to develop a comprehensive and adaptive global information system, to take maximum advantage of global operations. However, a balance is to be maintained, not to such a point where the very purpose of the effectiveness of communications and information flow is defeated. An effort should be made to employ financial management techniques covering data and information flow at a global level for the optimization of profitability. This can be done by having information pooled and analyzed as a whole to create a comprehensive global funds flow management system. Global Sources of Capital Many sources of public and private funds are available to the global corporation. Multilateral lending institutions like the International Development Association, the International Bank for Reconstruction and Development and the International Finance Corporation were designed to provide financial support to less developed countries on a private as well as public basis. The equity capital market is another available source of financing, with the three largest international stock exchanges in the world being the New York, Tokyo and London Stock Exchange. With the standardization of reporting practices for security offerings hy EEC, the use of European stock exchanges by non-members should also be enhanced. Several stock exchanges have also developed recently in Asia. CDC of the UK, COFACE of France, HERMES of Germany and various other subsidized lending bodies promoted by various developed countries are also available sources of funding for developing countries. Some of these while being industry-specific jn addition to being region or country-specific, are often cheap sources of funds, though their process time is fairly long. One source of funds available for European ventures are their own capital markets. This includes Eurocurrency which is banked outside its country of origin, as in Eurodollars, which are dollar deposits outside the USA. Sales abroad will usually be financed by bank borrowings at home supported by export credit guarantees. Construction projects may be funded by a combination of home and foreign sources through a consortium of banks, supported sometimes by international monetary agencies like the World Bank. In areas of foreign collaboration, agents, licensees and other partners are normally financed from their national sources. They may however receive funding from abroad as well, some from the parent company. Mechanisms for effecting foreign exchange transactions include:
Some new variations in the area of financial instruments have developed in recent years.
It is essential that funds for investment are available at the right time, in the right place and at the lowest possible cost. Often I ejects get delayed because funding packages are not in place and the lead time for this is not anticipated, resulting not only in project implementation being off schedule, but usually in cost escalation as well. The cost for any particular project depends on exchange rate ones and interest rates. Generally countries with high interest rates also have a high inflation rate and the cost of capital is less than it appears as repayments are made out of devalued funds. The preferred means of raising capital will depend on the proposed use of the funds. A firm has to determine the optimum finance package based on the ability of the project/business the bear the cost. If the project has a long gestation period, loans fron-financial institutions, where the interest rate is lower, are preferred whereas if a short gestation/quick return period is involved, loan; with higher interests can be risked. |
