International Business

Block

2
GLOBAL MARKETS AND INSTITUTIONS

UNIT 4
International Monetary System 1-22

UNIT 5
Foreign Exchange Markets 23-44

UNIT 6
International Economic Integration and Institutions 45-69
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April, 2022. All rights reserved
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ii
BLOCK 2: GLOBAL MARKETS AND INSTITUTIONS
The second block to the course on International business gives an overview of international
monetary system and foreign exchange markets and international economic integration and
institutions. The block contains three units. The first unit discusses about the international
monetary system. The second unit deals with the foreign exchange markets. The third unit
discusses international economic integration and different institutions affecting global-
level cooperation, regional agreements, international commodity agreements, and the
strategies adopted by multinational enterprises in response to regional economic
integration.

The first unit, International Monetary System discusses the history of the international
monetary system. It goes into explaining different exchange rate systems. It then discusses
the methods that help in determining foreign exchange rates. The unit finally discusses the
concept of balance of payments and its accounts.

The second unit, Foreign Exchange Markets discusses different concepts in international
foreign exchange rate markets. It then goes into explaining the different international
capital markets. It finally discusses three perspectives that highlight the causes for the Asian
financial crisis.

The third unit, International Economic Integration and Institutions discusses the different
forms of economic integration. It then goes into explaining the role of three fundamental
institutions affecting cooperation among nations at the global level – the World Trade
Organization, the International Monetary Fund, and the World Bank. It then discusses
different regional agreements and international commodity agreements. It finally discusses
the strategic responses of multinational enterprises to regional economic integration.

iii
 Unit 4
International Monetary System
Structure
4.1 Introduction
4.2 Objectives
4.3 History of the International Monetary System
4.4 Exchange Rate Systems
4.5 Determining Foreign Exchange Rates
4.6 The Balance of Payments
4.7 Summary
4.8 Glossary
4.9 Self-Assessment Test
4.10 Suggested Readings/Reference Material
4.11 Answers to Check Your Progress Questions

Monetary policy is like juggling six balls.it is not 'interest rate up, interest rate
down.' There is the exchange rate, there are long term yields, there are short
term yields, there is credit growth.
- Raghuram Rajan

4.1 Introduction
The previous block gave an overview of international business and globalization.
It also dealt with trade theories and their application in international business and
the trade barriers that hinder international business. It finally discussed the
country differences in the cultural, political, and legal environmental contexts.
International business is carried out in an uncertain environment in which the
exchange rates are very volatile. The volatile exchange rates increase the risk for
international firms. An understanding of the international monetary system helps
in managing foreign exchange risk.
Balance of payments records economic transactions between one country and rest
of the world.
This unit will discuss the history of the international monetary system. It then
goes into explaining different exchange rate systems. It then discusses the
methods that help in determining foreign exchange rates. The unit finally
discusses the concept of balance of payments and its accounts.
Block 2: Global Markets and Institutions

4.2 Objectives

By the end of this unit, students should be able to:

 Trace the history of the international monetary system.
 Describe the different exchange rate systems.
 Identify the methods used for determining foreign exchange rates.
 Explain the concept of balance of payments and its accounts.

4.3 History of the International Monetary System

The international monetary system refers primarily to “the set of policies,
institutions, practices, regulations, and mechanisms that determine foreign
exchange rates.” The system comprises currencies from individual countries in
addition to composite currency units such as the European Currency Unit (ECU)
and Special Drawing Right (SDR). Foreign exchange refers to “the money of a
foreign country, such as foreign currency bank balances, banknotes, checks, and
drafts.” A foreign exchange rate is “the price of one currency expressed in terms
of another currency (or gold).” A system can be classified as fixed or managed
exchange rate system if the government of a country regulates the rate at which
the local currency can be exchanged for other currencies. If a country’s currency
is pegged or tied to currency of another country, it is called pegged exchange rate
system. “The rate at which the currency is fixed is often referred to as its par
value.” If a government does not interfere in the currency valuation, it is classified
as floating or flexible exchange rate system. The real exchange rate is “the
exchange rate after deducting an inflation factor.” The nominal exchange rate is
“the exchange rate before deducting an inflation factor.”

Example
As reported in ceicdata, with an updated information up to 21st February 2018,
France’s foreign Exchange Rate Index before deducting inflation factor
showed an increase of 1.246 points from the previous level of 96.420 as on
Dec2016 to 97.666 as on 31st December 2017.This exchange rate is a nominal
exchange rate
Source: ICFAI Research Center

The changes in exchange rates may move in one of the two directions. Associated
with the fixed exchange rate system, devaluation of a currency refers to “a drop
in the foreign exchange value of a currency that is pegged to another currency or
gold.” Associated with the floating exchange rate system, depreciation refers to
“a drop in the foreign exchange value of a floating currency.” Appreciation refers
to “a gain in the foreign exchange value of a floating currency.”

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 Unit 4: International Monetary System

The choice of foreign currencies used by international firms influences their cash
flows and income levels. For instance, firms in countries with soft currencies use
hard foreign currencies in their export businesses. A soft or weak currency is “one
that is anticipated to devaluate or depreciate relative to major trading currencies.”
A currency is considered hard or strong if it is “expected to revalue or appreciate
relative to major currencies.”
A brief review of the history of the international monetary system can help in
understanding the current monetary system and appraise the strengths and
weaknesses of different foreign exchange systems.
4.3.1 The Gold Standard Period (1876-1914)
Gold was used as an exchange medium and a store of value since the days of the
pharaohs (about 3000 B.C). In the 1870s, the gold standard was accepted as an
international monetary system. Under this system, each country pegged its
currency to gold.
The governments using the gold standard agreed to buy or sell gold on demand at
their own fixed parity rate. Thus, the value of each currency in terms of gold and
the fixed parities between currencies remained stable. The system required the
countries to maintain an adequate reserve of gold to back their currency’s value.
The gold standard worked adequately until World War I that interrupted trade
flows and free movement of gold. Thus, the major trading nations suspended the
gold standard.
In the version called Gold Specie Standard, the actual currency in circulation
comprised gold coins with a fixed gold content. In the version called Gold Bullion
Standard, the basis of money remained gold in fixed weight but the currency in
circulation consisted of paper notes, where the authorities were ready to convert
on demand unlimited amounts of gold into paper currency and vice versa at a
fixed ratio of conversion. For instance, a dollar note can be converted into say x
ounces of gold, while a pound sterling note can be exchanged for say y ounces of
gold on demand.
4.3.2 The Inter-War Years and World War II or Gold Exchange Standard
(1914-1944)
During World War I and the early 1920s, currencies were allowed to fluctuate
over wide ranges in terms of another currency and gold. This led to the creation
of arbitrage opportunities for international speculators. Such fluctuations led to
hampering of the world trade in the 1920s thus resulting in the Great Depression
in the 1930s. The gold standard broke down during World War I and was
reinstated briefly from 1925-1931 as the Gold Exchange Standard. Under this
standard, only the US and England could hold only gold reserves but other
countries could both gold and dollars or pounds as reserves.

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Block 2: Global Markets and Institutions

Under the Gold Exchange Standard, the authorities may convert on demand at a
fixed rate, the paper currency issued by them into the paper currency of another
country which is operating at a gold specie standard or gold bullion standard. Thus
if rupees could freely convertible into dollars and dollars into gold, rupee is said
to be on a gold exchange standard.
The exchange rate between any two currencies could be determined by their
corresponding exchange rates against gold. This is called as the mint-parity rate
of exchange.
Under the gold standard, the money authorities need to obey the following rules:
1. They must fix once-for-all the conversion rate of the paper currency issued
into gold.
2. There should be free flows of gold between countries on gold standard.
3. The money supply must be tied to the amount of gold held by the monetary
authorities in reserve. If this amount decreases, money supply must contract
and vice versa.

In 1931, England departed from gold in the face of massive gold and capital flows
due to an unrealistic exchange rate, and the Gold Exchange Standard was finished.
In 1934, the US returned to a modified gold standard, when the dollar was
devalued to $35 per ounce of gold from $20.67 per ounce of gold in price. Though
the US returned to the gold standard, gold was not traded with individual citizens
but only with foreign central banks. From 1934 to the end of World War II, the
exchange rates were determined by each currency value in terms of gold.
However, during the World War II and its aftermath, many of the major trading
currencies lost their convertibility into other currencies. The dollar remained the
only major trading currency that continued to be convertible.

4.3.3 The Bretton Woods System (1944-1973)

This period was characterized by a fixed exchange system. Under the provisions
of the Bretton Woods Agreement that was signed in 1944, the governments of all
the member countries took a pledge for maintaining a fixed or pegged exchange
rate for its currency vis-à-vis gold or the dollar. Fixing the gold price of a currency
was equivalent its exchange rate in relation to the dollar, because one ounce of
gold was equal to $35. The countries participating in the agreement agreed to
make effort to maintain their currency values within a 1 percent band by buying
or selling gold or foreign exchange as needed. Devaluation could not be used as
a competitive trade policy, but in case the currency became too weak to defend,
the currency could be devaluated up to 10 percent without formal approval from
the International Monetary Fund (IMF).
During this period, the US dollar was the key to the web of exchange rate values
and was the main reserve currency held by central banks. Unfortunately, the US

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 Unit 4: International Monetary System

grew deficits on it balance of payments. To finance these deficits and meet the
growing demand for dollars from businesses and investors, a heavy capital
outflow of dollars was required. Eventually, a heavy overhang of dollars held
abroad resulted in the lack of confidence in the ability of the US for meeting its
commitment to convert dollars to gold. On August 15, 1971, the US gave response
to the huge trade deficit by making the dollar inconvertible to gold. A program
for wage and price controls was introduced and 10 percent surcharge was placed
on imports. Many major currencies were allowed to float against the dollar. Then
the dollar began the decade of decline.
Under the Smithsonian Agreement, which was reached in Washington DC in
December 1971, among the world’s trading nations; the US agreed to devalue the
dollar to $38 per ounce of gold. In return, the other countries present decided to
revalue their currencies upward by specified amounts relative to the dollar. Actual
revaluation ranged from 7.4 percent in Canada to 16.9 percent in Japan.
Furthermore, the allowed floating band was expanded from ±1 to ±2.5 percent.
The high inflation in the US resulted in the dollar devaluation remaining
insufficient in restoring stability to the system. By 1973, even at devalued rates,
the dollar was under heavy selling pressure. By February 1973, a fixed-rate
system was no longer feasible given the speculative currency flows. In March
1973, major foreign exchange markets were closed for several weeks and after
they reopened, most currencies were permitted to float to levels that were
determined by market forces.
4.3.4 The Post-Bretton Woods System: 1973-Present
This period is characterized by a floating exchange rate system. Since March
1973, the exchange rates had become very volatile and less predictable than they
were during the fixed exchange rate period. The system became more volatile as
it approached the oil crisis in 1973. By October 1973, the Organization of
Petroleum Exporting Countries (OPEC) made successful efforts to raise the oil
prices. By 1974, the oil prices had quadrupled. Several nations, especially the US,
made efforts to offset the high energy bills by boosting spending. This resulted in
high inflation and vast deficits in the balance of payments, which eventually
caused the dollar crisis of 1977-1978.
During 1981-1985, the US dollar rebounded strongly due to President Regan’s
economic policy. However, the dollar resumed its downhill slide attributed chiefly
to a slowdown in the US and changes in US government policy. After the dollar
had declined considerably, the US, Japan, West Germany, France, Britain, Italy,
and Canada – also known as Group of Seven (or G-7) met in February 1987 and
agreed to slow the fall of the dollar. This agreement, also known as Louvre
Accords required the G-7 nations to support the falling dollar by pegging
exchange rates within an undisclosed and narrow range. In early 1988, the dollar
rallied, thereby ending it dramatic volatility. In 1990, the US dollar fell again and
stayed flat during 1991-1992. In 1993, it fell against the Japanese yen and DM.

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Block 2: Global Markets and Institutions

The third major crisis of the 1990s was the turmoil rocking the Asian foreign
exchange markets since June 1997. The predecessors were the crisis in the
European Monetary System (EMS) of 1992-1993 and the Mexican peso crisis of
1994-1995. The Asian crisis was started by the collapse of the Thai currency, the
baht. In one month, the baht had lost 20 percent of its value against the dollar. The
currencies of Indonesia, Malaysia, and the Philippines had also weakened. In
August 1997, the Indonesian authorities were forced to allow rupiah, their
national currency, to freely move against other currencies. In December 1997, the
IMF put a US$ 58.4 billion international bailout for Korea. The Koreans decided
to float the won. In August 1998, the Russian authorities devalued the ruble due
to the rapidly deteriorating foreign currency reserves. The US Federal Reserve
responded to the US credit crunch by lowering the interest rates thrice in quick
succession, including a unilateral move by Alan Greenspan, Fed Chairman. In
September 1998, other industrialized countries such as Japan, Canada, and most
of the European nations also eased monitory policies. In October 1998, the G-7
nations endorsed a plan for allowing the IMF to lend to countries before they get
into financial troubles.

4.4 Exchange Rate System

4.4.1 Fixed-rate System
Under a fixed (or pegged) exchange rate system, the value of a currency in terms
of another is fixed. These rates are determined by governments or the central
banks of the respective countries. The fixed exchange rates result from countries
pegging their currencies to either some common commodity.
Under a fixed-rate system, governments can buy or sell their currencies in the
foreign exchange market whenever there is a deviation in the stated par values. A
few centrally planned economies such as North Korea and Cuba have employed
a purely fixed-rate system. In these economies, it is usually mandatory that the
foreign exchange earnings of a local firm had to be surrendered to the central bank
for which the firm receives a return, a corresponding amount in local currency.
The foreign exchange income is allocated by the central bank to state-owned users
based on governmental priorities.

Example
As per a report in The Observatory of Economic Complexity (OEC) dated 11th
March 2019, there has been a steady decline in exports of North Korea at an
annual rate of 9 % resulting in a negative trade balance of $1.69B in the year
2017. In the F Y 2017, North Korea exported $1.74B and imported $3.42B, of
which the total exports to India was just $25M.

Contd….

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 Unit 4: International Monetary System

The companies in North Korea which have exported the goods have to
surrender the foreign exchange earnings to the Central Bank of N. Korea and
they in turn pay in local currency at an exchange rate determined by them to
the companies. Thus whenever there is a change in the stated par value, the
government buys the foreign exchange and this is one of the reasons for
reduction in exports.
Source: ICFAI Research Center

4.4.2 Crawling Peg System

The peg system is situated between the fixed-rate and float-rate systems. The
crawling peg is “an automatic system for revising the exchange rate, establishing
a par value around which the rate can vary up to a given percentage point.” The
par value is regularly revised according to the formula which is determined by the
authorities. After the par value is set, the central bank intervenes whenever the
market value approaches a limit point. For instance, if the par value of the
Mexican peso is 3,000 pesos for one dollar and that it can vary ±2 percent around
this rate, between 3,060 pesos and 2,940 pesos. If the dollar approaches the rate
of 3,060 pesos, the central bank intervenes by selling dollars and buying pesos. If
the dollar approaches the rate of 2,940 pesos, the central bank intervenes by
selling pesos and buying dollars.
A government can peg its currency either to a single currency or basket of foreign
currencies. Other countries peg their currency to a composite basket of currencies,
where the basket comprises a portfolio of currencies of their major trading
partners. This basket has base value which is stable than any single currency.
Under this regime, a country can peg its currency to the standard basket such as
SDRs (e.g. Myanmar, Libya), or its own basket, which is designed to fit the
unique trading and investing needs of a country (e.g. Czech Republic, Jordan,
Cyprus, Bangladesh, Israel, Iceland, Kuwait, Nepal, Thailand, and Morocco). In
the latter approach, the basket contains currencies of major trading partners.

Example
Israel’s exchange rate is linked to the currencies of its major trading partners
such as US and China. The exchange rate followed by Israel gets automatically
revised establishing a par value around which the rate varies up to a given
percentage point. The high – low exchange rate between August 2019 to
October 2019 of Israel Shakel ILS was 3.510 to 36.445 / US$, a variation
around 1.88%.
Source: ICFAI Research Center

The peg system is a universal remedy. When pegged rates get overvalued,
countries have to forcibly deplete their foreign exchange reserves for defending
the currency peg. When reserves get depleted, countries attempt to manipulate

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Block 2: Global Markets and Institutions

interest rates but are often forced to devalue, repegging at a low rate or giving up
the peg in total. With a floating rate system, countries can maintain their reserves
and hence can maintain a defense against financial panic. Foreign creditors
understand that the central bank has reserves sufficient for paying short-term
debts, thus eliminating the possibility of a self-fulfilling creditor panic.

Activity 4.1
A country had fixed its currency against the dollar. Due to high inflation in the
country, the currency had to be devalued highly. As the rapid devaluation create
instability, the country had to implement an exchange rate system. Which
exchange system should be employed by the country in order to ensure that its
currency is not devalued significantly? Also discuss the exchange rate system.
Answer:

4.4.3 Target-zone Arrangement

Target-zone arrangement is “virtually a joint float system cooperatively arranged
by a group of nations sharing common interests and goals.” Under this system,
countries make adjustments to their national economic policies for maintaining
their exchange rates within a specific margin around fixed central exchange rates
that are agreed upon. The target-zone arrangement exists for major European
currencies that participate in the EMS. The European Union members have a
cooperative agreement for maintaining their currencies within a set range against
other group members. The EMS is “a peg of each country’s currency to all the
others, as well as joint float of all member currencies together against non-EMS
currencies.” The target-zone arrangement helps in minimizing the instability in
exchange rates and enhances economic stability in the group.

Example
European commission on its website dated 27th April 2021 has reported that the
total trade in goods between the EU and Algeria in 2020 amounted to €24.9
billion. The imports amounted to €11.4 billion and exports to Algeria amounted
to €13.5 billion. Both Algeria and the EU adjust their exchange rates within a
specific margin around fixed central exchange rates that were agreed upon.
Here, target-zone arrangement is a kind of exchange rate agreement exists
between the EU and Algeria.

Source: ICFAI Research Center

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 Unit 4: International Monetary System

However, the target-zone arrangement is not without problems. Due to the

divergence of national policies, the trade structure and the level of economic
development, it gets difficult for every member to maintain the central exchange
rate for a longer time period. Moreover, if the currency speculators attack one of
the zone currencies, defense becomes very costly.
4.4.4 Managed Float System
Also known as dirty float, the managed float is designed for eliminating
excess volatility. It is employed by governments to preserve an orderly pattern
of changes in exchange rates. Each central bank sets the exchange rate of a nation
against a predetermined goal, but allows the exchange rate to vary. In other words,
the change in exchange rates does not take place automatically, but is based on
the view of the government of an appropriate rate in the context of the country’s
position in balance of payments, foreign exchange reserves, and rates that are
quoted outside the official market. The authorities, rather than resisting the
underlying forces, sometimes intervene by selling or buying domestic currency
for smoothing the transition from one rate to another. At other times, the
authorities intervene for moderating or counteracting self-correcting cyclical or
seasonal market forces. The rationale for the managed float system is to reduce
uncertainty for improving the economic and financial environments. For instance,
the intervention of the government may reduce the uncertainty of the exporters
caused by disruptive exchange rates. Some of the countries that maintain a
managed float system include Brazil, China, Israel, Egypt, Hungary, Korea,
Poland, Turkey, Russia, etc.

Example
As per a report in Business Standard dated 13th April 2019, the cotton exports
to China from India has increased substantially. India’s cotton, textiles and
apparel exports increased by about 69 per cent from $ 919.76 million to $1.5
billion between April 2018 and February 2019 over the corresponding period
last year. Due to the trade war between US and China, there could have been a
considerable volatility in exchange rates which could have affected the export
proceeds by Indian companies. However the Chines government in order to
eliminate the excess volatility in the exchange rates allows its Central Bank to
intervene to keep the exchange rate volatility under control.
Source: ICFAI Research Center

4.4.5 Independent Float System

The independent float system is also known as clean float. Under this system, an
exchange rate is allowed to freely adjust to the demand and supply of this currency
for another. As a consequence of this, the economy does not have to undergo the
painful adjustment process set in motion by an increase or decrease in the supply

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Block 2: Global Markets and Institutions

of money. This category includes currencies of both developed (e.g. the USA) and
developing nations (e.g. Peru). The central banks of these countries allow market
forces to determine the exchange rates. The central banks may intervene from
time to time to alleviate speculative pressures on their currency. They also
intervene occasionally as one of the anonymous participants in the free market.

Example
The Hindu dated 5th December 2021 has published an article on the
appreciation by the US treasury department on Forex intervention by RBI. The
article mentions that India has been exemplary in publishing its foreign
exchange market intervention, adding that New Delhi should allow the
exchange rate to move flexibly and freely to the demand and supply of the
currency for another to reflect economic fundamentals. Here, independent float
system is the type of exchange system that the US treasury wants India to
adopt.
Under this system, an exchange rate is allowed to freely adjust to the demand
and supply of this currency for another which is the crux of the US treasury
inputs and suggestions on India’s exchange rate system.

Source: ICFAI Research Center

4.4.6 Floating system – Advantages and Disadvantages

The flexible exchange rate system offers a less painful adjustment mechanism to trade
imbalances than fixed exchange rates and prevents a country from large persistent
deficits. Flexible exchange rates only lower the foreign exchange value of a
currenc9y unlike the fixed-rate system, which requires recession to reduce real
income or prices when trade deficits arise.
Flexible exchange rates do not require central banks to hold foreign exchange
reserves as there was no need for intervention in the foreign exchange market.
They also avoid the need for strict imports and exports regulations such as import
restrictions, foreign exchange control, and tariffs, Finally, floating exchange rates
can help in ensuring the independence of trade policies.
However, the role of flexible rates is limited in balancing trade after a certain
time period. A currency devaluation or depreciation will help the balance of trade
if it reduces the relative prices of goods and services produced locally. However,
after a short-time period, domestic prices of tradable goods will rise following
devaluation or depreciation. This results in an increase in cost of living, which
in turn puts upward pressure on wages. In addition, flexible rates could increase
the difficulty for the government in controlling inflation and also creates less
motivation for the governments for combating it. Finally, free floats may lead to
more uncertainty, which may in turn hamper the stability and growth of
economies vulnerable to international financial and export markets.

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 Unit 4: International Monetary System

4.5 Determining Foreign Exchange Rates

During the gold standard regime (1876-1914), the base level of the exchange rate
could be determined by the stated value of the gold per unit of the currency.
However, under other foreign exchange rate regimes, there is no direct way for
valuing a currency against other currencies in terms of flows as well as stocks.
Moreover, the current international monetary system is a blend of free floating,
managed floating, pegged or target zone, and fixed exchange rates. There is no
single general theory that forecasts foreign exchange rates under all conditions.
But it is agreed widely that the purchasing power parity (PPP) principle helps in
explaining both the stocks and the flows of exchange rates. Other principles that
help in analyzing foreign exchange movements include interest rate parity and
international Fisher parity. The PPP approach lays emphasis on the role of prices
of goods and services in determining exchange rates whereas the role of capital
movements is focused by interest rate parity.

4.5.1 Purchasing Power Parity

The purchasing power parity (PPP) principle states that in the long run, the
exchange rate between two currencies should reflect differences in purchasing
power, that is, the exchange rate should equalize the price of identical goods and
services in two countries. The PPP principle has two perspectives such as absolute
PPP and relative PPP. Absolute PPP suggests that the exchange rate can be
determined by the relative prices of identical baskets of goods and services. For
instance, if the identical basket of goods cost ¥ 100 in Japan and $ 1 in the US,
the PPP-based exchange rate would be ¥ 100/$ 1.
Due to difference in consumption behaviors and demand structures, different
basket of goods is used in different countries. This deficiency can be avoided by
relative PPP which focuses on the relationship between price changes of two
countries and change in exchange rates during the same period. According to
relative PPP, if the exchange rate starts in equilibrium between two countries, any
change in the differential inflation rate between them tends to be offset in the long
term by an opposite equal change in the exchange rate. The exchange rate
depreciates if the domestic inflation level rises faster than the foreign inflation
level. The exchange rate appreciates if the foreign inflation level rises faster than
the domestic inflation level. In this situation, if there is no change in the exchange
rate, the export of goods and services in a country will become less competitive
with comparable products produced elsewhere. Imports would also become more
price-competitive than domestic products that are highly priced.
The PPP principle offers an economic foundation that determines and adjusts
exchange rates. However, in the real business world, PPP conditions may not
always hold. Thus the exchange rates are always not determined by PPP.

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Block 2: Global Markets and Institutions

4.5.2 Interest Rate Parity (IRP)

The PPP principle focuses only on goods and services and excludes the
importance of capital flows while determining exchange rates. This limitation is
addressed by the interest rate parity (IRP) principle which explains how interest
rates are linked between different countries through capital flows. The IRP
principle suggests that “the difference in national interest rates for securities of
similar risk and maturity should be equal to, but opposite in sign of, the forward
rate discount or premium for the foreign currency.” A forward rate is “the rate at
which a bank is willing to exchange one currency for another at some specified
future date.” If the exchange takes place immediately, it is termed as spot rate. A
forward rate discount measures the percentage by which the forward rate is more
or less than the spot on a specific date. The IRP implies that the forward premium
of exchange rate will match the interest rate differential between two countries.
This relation holds because of efficient arbitrage in risk-free assets. It can be
applies to international lending as well as international investments. The rationale
underlying IRP is that for financing projects, borrowers compare the costs in
domestic market with that of the foreign market. For investment projects,
investors compare the return from the domestic market with the return from the
foreign market. When interest parity is established, equilibrium will be achieved.
Like PPP, IRP also faces deviations due to tax factors and transaction costs in financial
markets. The deviations from interest parity between countries is also caused by political
risks because expect to be compensated from the greater risk of investing in a foreign
country.
In general, IRP is applicable to securities that have maturities of one year or less
since forward contracts are not available for period more than a year.
Similar to the principle of IRP but involving securities with maturity for over a
year, the international Fisher effect addresses the relationship between the change
in percentage in the spot exchange rate over time and the differential between
interest rates that are comparable in different national capital markets. The
international Fisher effect states that “the spot exchange rate should change in an
equal amount but in opposite direction to the differences in interest rates between
two countries.”
4.5.3 Implications for MNEs: Foreign Exchange Forecasting
Participants in international financial markets can never for sure what the
exchange rate would be after a month as future exchange rates are uncertain.
Hence, forecast should be made. Some forecasters believe that for major floating
currencies, forward exchange rates are unbiased predictors of future spot
exchange rates and forward exchange rates are efficient. On the other hand, this
hypothesis was rejected by empirical studies. Though reference to forward rate is
necessary, international managers should take into account many economic and
non-economic factors to predict foreign exchange rates.

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 Unit 4: International Monetary System

Economic factors influencing long-term exchange rates include balance of

payment, foreign exchange reserves, relative interest rates, relative inflation rates,
and the longterm properties of PPP. The long-term exchange rates of a country
are also influenced by the strength of a focal country’s economy, which is
reflected often in its Gross Domestic Product, national income, export growth,
and investment growth. As governments differ in which they exert influence on
foreign exchange rates, even under the floating system, managers should have
awareness about government declarations and agreements regarding exchange
rate goals. Non-economic factors include political or social events, market
speculations against the currency, bilateral relations between the two countries,
the confidence of market participants, and natural disasters.
In emerging markets where the foreign exchange control is set by the government,
there usually exists a foreign exchange black market where the buyers and sellers
transact foreign currencies using the market rate, which is different from the
official rate. International managers also take into consideration the country’s
foreign exchange rate system in predicting exchange rates. For predicting a long-
term fixed rate, managers should also see if the government has the capability to
control domestic inflation for generating hard currency reserves and to run trade
surpluses. For predicting a long-term floating rate, managers should focus on
inflationary fundamentals and PPP as well as economic health indicators such as
stability and growth.
Time-series analysis is a technique widely applied for predicting foreign exchange
rates, particularly short-term trends.

Activity 4.2
If the price of a movie ticket in the US is US$ 5, the correct exchange rate
would be one that exchanges US$ 5 for the amount of Japanese yen it would
take to purchase a movie ticket in Japan. If the ticket price is ¥540, what should
be the exchange rate between two currencies so that a moviegoer can purchase
a ticket regardless of which country he/she goes in? Identify the concept and
discuss it in brief.
Answer:

4.6 The Balance of Payments

The exchange rate system is a tool essential for international transactions that
involves multiple currencies. The national goal of international transactions is to
accomplish gains from investment and trade activities, which are recorded in the

13
Block 2: Global Markets and Institutions

balance of payments account. The balance of payments is “an accounting

statement that summarizes all the economic transactions between residents
(individuals, companies, and other organizations) of the home country and other
countries.” It reports the international performance of a country in trading with
other nations and the volume of capital that flows in and out of the country. The
balance of payments uses the double-entry bookkeeping system, which means that
every credit or debit in the account is reflected as credit or debit somewhere else.
In the balance of payments sheet, inflows of currency are recorded as credit (plus
sign) and outflows of currency are recorded as debit (minus sign).
A standard balance of payments includes current account, capital account, and
official reserves account. Statistical discrepancy is also included in the balance of
payments account for maintaining the balance of total credit and total debit.
Statistical discrepancy reflects omissions and net errors in collecting data on
international transactions.
4.6.1 Current Account
The current account records “flows of goods, services, and unilateral transfers.”
It includes service transactions (also called as invisible items) and exports and
imports of merchandise (trade balance). The service account includes several
service income and fees (e.g. royalty, interests, and dividends). Service income
includes transportation charges (i.e. shipping and air travel), financial charges (i.e.
banking and insurance), and tourism income. The investment income account
separates investment income from service income and records income payments
on foreign-owned assets within the country and income receipts on the country-
owned assets abroad. Unilateral transfers include remittances, pensions, and other
transfers for which specific services are not furnished.

Example
The Hindu dated 1st of October 2021 has reported that India’s merchandise
exports grew 21.3% year-on-year to $33.44 billion in September 2021 and were
28.5% higher than pre-COVID levels of September 2019. Merchandise imports
grew faster to $56.38 billion, 84.75% higher than September 2020 and nearly
50% over pre-pandemic levels, as per preliminary estimates. Here, in the
current account the above transactions of imports and exports of merchandise
be recorded.
Source: ICFAI Research Center

4.6.2 Capital Account

The capital account records “private and public investment or lending activities
and is divided into portfolio (short and long-term) and foreign direct investment.”
Direct investments include wholly-owned subsidiaries, joint ventures, and foreign
branches. Portfolio investments include mutual funds, foreign bonds, and notes.

14
 Unit 4: International Monetary System

The portfolio account includes both short-term (e.g. cash, bills, deposits, etc.) as
well as long-term (e.g. securities, mortgages, bank loans, etc.) investments or
lending. Government lending and borrowing are also part of the capital account.

Example
th
Reuters dated 14 September 2021 has reported that India has attracted foreign
direct investment at record levels even during the COVID-19 pandemic with
total FDI inflows amounting to $81.72 billion in 2020-21, 10% higher than the
previous financial year and this has resulted in BoP surplus for FY21 at a robust
$87.3 billion. In the given case, capital account is the BoP account where the
FDI inflows of $81.72 billion be accounted for.
Source: ICFAI Research Center

Check Your Progress - 1

1. The refers primarily to the set of policies, institutions, practices.

a. European monetary system
b. Domestic monetary system
c. International monetary system
d. Fixed exchange rate system
2. __________refers to the money of a foreign country, such as foreign currency
bank balances, banknotes, checks, and drafts.
a. Fixed exchange
b. Floating rate
c. Foreign exchange
d. Domestic exchange
3. A is the price of one currency expressed in terms of another currency
(or gold).
a. Foreign exchange rate
b. Forward rate
c. Spot rate
d. None of the above
4. The ___________ is the exchange rate after deducting an inflation factor.
a. Nominal exchange rate
b. Foreign exchange rate
c. Real exchange rate
d. Spot exchange rate

15
Block 2: Global Markets and Institutions

5. The_________ is the exchange rate before deducting an inflation factor.

a. Real exchange rate
b. Nominal exchange rate
c. Foreign exchange rate
d. None of the above
6. ______refers to a drop in the foreign exchange value of a floating currency.
a. Revaluation
b. Appreciation
c. Devaluation
d. Depreciation
7. ______refers to a gain in the foreign exchange value of a floating currency.
a. Devaluation
b. Revaluation
c. Appreciation
d. Depreciation
8. Under the provisions of the ______that was signed in 1944, the governments
of all the member countries took a pledge for maintaining a fixed or pegged
exchange rate for its currency vis-à-vis gold or the dollar.
a. Gold standard period
b. Post Bretton Woods system
c. Smithsonian agreement
d. Bretton Woods Agreement
9. Under a_________, governments can buy or sell their currencies in the
foreign exchange market whenever there is a deviation in the stated par
values.
a. Floating rate system
b. Crawling peg
c. Fixed-rate system
d. Target-zone arrangement
10. The ________is an automatic system for revising the exchange rate,
establishing a par value around which the rate can vary up to a given
percentage point.
a. Target-zone arrangement
b. Fixed-rate
c. Floating rate
d. Crawling peg

16
 Unit 4: International Monetary System

11. ___________ is virtually a joint float system cooperatively arranged by a

group of nations sharing common interests and goals.
a. Crawling peg
b. Target-zone arrangement
c. Fixed-rate
d. Floating rate
12. In a/an _______, an exchange rate is allowed to freely adjust to the demand
and supply of this currency for another.
a. Independent float system
b. Managed float system
c. Fixed-rate system
d. Crawling peg system
13. The_______ principle states that in the long run, the exchange rate between
two currencies should reflect differences in purchasing power, that is, the
exchange rate should equalize the price of identical goods and services in two
countries.
a. Interest rate parity
b. Purchasing power parity
c. Floating system
d. Crawling peg
14. The ________principle suggests that the difference in national interest rates
for securities of similar risk and maturity should be equal to, but opposite in
sign of, the forward rate discount or premium for the foreign currency.
a. Managed float
b. Fixed rate
c. Interest rate parity
d. Purchasing power parity
15. The _________ is an accounting statement that summarizes all the economic
transactions between residents of the home country and other countries.
a. International monetary system
b. Profit and loss
c. Cash flow
d. Balance of payments

17
Block 2: Global Markets and Institutions

4.7 Summary
 The international monetary system refers primarily to the set of policies,
institutions, practices, regulations, and mechanisms that determine foreign
exchange rates.
 In the 1870s, the gold standard was accepted as an international monetary
system. Under this system, each country pegged its currency to gold.
 During World War I and the early 1920s, currencies were allowed to fluctuate
over wide ranges in terms of another currency and gold. This led to the
creation of arbitrage opportunities for international speculators.
 Under the provisions of the Bretton Wood Agreement that was signed in
1944, the governments of all the member countries took a pledge for
maintaining a fixed or pegged exchange rate for its currency vis-à-vis gold or
the dollar.
 The Post-Bretton Woods system is characterized by a floating exchange rate
system.
 Under a fixed-rate system, governments can buy or sell their currencies in the
foreign exchange market whenever there is a deviation in the stated par
values.
 The crawling peg is an automatic system for revising the exchange rate,
establishing a par value around which the rate can vary up to a given
percentage point.
 Target-zone arrangement is virtually a joint float system cooperatively
arranged by a group of nations sharing common interests and goals.
 Also known as dirty float, the managed float is designed for eliminating
excess volatility. It is employed by governments to preserve an orderly pattern
of changes in exchange rates.
 The independent float system is also known as clean float. Under this system,
an exchange rate is allowed to freely adjust to the demand and supply of this
currency for another.
 The purchasing power parity (PPP) principle states that in the long run, the
exchange rate between two currencies should reflect differences in purchasing
power, that is, the exchange rate should equalize the price of identical goods
and services in two countries.
 The Interest Rate Parity principle suggests that the difference in national
interest rates for securities of similar risk and maturity should be equal to, but
opposite in sign of, the forward rate discount or premium for the foreign
currency.

18
 Unit 4: International Monetary System

 The balance of payments is an accounting statement that summarizes all the

economic transactions between residents (individuals, companies, and other
organizations) of the home country and other countries.
 A standard balance of payments includes current account, capital account, and
official reserves account.

4.8 Glossary
Appreciation: Appreciation refers to gain in the foreign exchange value of a
floating currency.
Balance of payments: Balance of payments is an accounting statement that
summarizes all the economic transactions between residents (individuals,
companies, and other organizations) of the home country and other countries.
Crawling peg: Crawling peg is an automatic system for revising the exchange
rate, establishing a par value around which the rate can vary up to a given
percentage point.
Depreciation: Depreciation refers to a drop in the foreign exchange value of a
floating currency.
Devaluation: Devaluation of a currency refers to a drop in the foreign exchange
value of a currency that is pegged to another currency or gold.
Foreign exchange: Foreign exchange refers to the money of a foreign country,
such as foreign currency bank balances, banknotes, checks, and drafts.
Foreign exchange rate: A foreign exchange rate is the price of one currency
expressed in terms of another currency (or gold).
Forward rate: Forward rate is the rate at which a bank is willing to exchange one
currency for another at some specified future date.
Hard currency: A currency is considered hard or strong if it is expected to
revalue or appreciate relative to major currencies.
International fisher effect: International Fisher effect states that the spot
exchange rate should change in an equal amount but in opposite direction to the
differences in interest rates between two countries.
International monetary system: The international monetary system refers
primarily to the set of policies, institutions, practices, regulations, and
mechanisms that determine foreign exchange rates.
Interest rate parity: The Interest Rate Parity principle suggests that the
difference in national interest rates for securities of similar risk and maturity
should be equal to, but opposite in sign of, the forward rate discount or premium
for the foreign currency.

19
Block 2: Global Markets and Institutions

Purchasing power parity: Purchasing Power Parity principle states that in the
long run, the exchange rate between two currencies should reflect differences in
purchasing power, that is, the exchange rate should equalize the price of identical
goods and services in two countries.
Soft currency: Soft or weak currency is one that is anticipated to devaluate or
depreciate relative to major trading currencies.
Target-zone arrangement: Target-zone arrangement is virtually a joint float
system cooperatively arranged by a group of nations sharing common interests
and goals.

4.9 Self-Assessment Test

1. Define the international monetary system. Give a brief history of the
international monetary system.
2. Explain in brief the different exchange rate systems.
3. Describe the principles that help in determining foreign exchange rates.
4. Define balance of payments.
5. A standard balance of payments includes current account, capital account,
and official reserves account. Explain these accounts in detail.

4.10 Suggested Readings/Reference Material

1. Charles W L Hill and G Thomas M Hult (2021). International Business –
Competing in the Global Marketplace. 12th edition, McGraw Hill India.
2. Oded Shenkar, Yadong Luo, Tailan Chi (2021). International Business, 4th
edition, Routledge
3. Alan C Shapiro (2019). Multinational Financial Management, 11th Edition,
Wiley
4. Prakash G Apte (2017). International Financial Management, 8th edition,
McGraw-Hill India
5. H.G.Mannu (2018). International Economics. Vikas Publishing House
6. Francis Cheunilam (2020). International Business – Text and Cases. 6th
edition. Prentice Hall India Learning Private Limited
7. John Wild and Kenneth Wild (2019). International Business – The Challenges
of Globalization. Pearson Education
Additional References:
1. Serenity Gibbons. How to expand your business internationally without
compromising your core model. Forbes (2020).
https://www.forbes.com/sites/serenitygibbons/2020/03/24/how-to-expand-a-
business-internationally-without-compromising-your-core-
model/?sh=66335a6f741d

20
 Unit 4: International Monetary System

2. IFRS Foundation. Use of IFRS standards around the world. 2018.

https://cdn.ifrs.org/-/media/feature/around-the-world/adoption/use-of-ifrs-
around-the-world-overview-sept-2018.pdf
3. Brett Steenbarger. Why diversity matters in the world of Finance. 2020.
https://www.forbes.com/sites/brettsteenbarger/2020/06/15/why-diversity-
matters-in-the-world-of-finance/?sh=36dba0637913
4. IFC. Social and Green Bonds.
https://www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corpor
ate_site/about+ifc_new/investor+relations/ir-products/socialbonds
5. Business Insider. Global ecommerce market report: ecommerce sales trends
and growth statistics for 2021. https://www.businessinsider.com/global-
ecommerce-2020-report?IR=T

4.11 Answers to Check Your Progress Questions

1. (c) International monetary system
The international monetary system refers primarily to the set of policies,
institutions, practices, regulations, and mechanisms that determine
foreign exchange rates.
2. (c) Foreign exchange
Foreign exchange refers to the money of a foreign country, such as
foreign currency bank balances, banknotes, checks, and drafts.
3. (a) Foreign exchange rate
A foreign exchange rate is the price of one currency expressed in terms
of another currency (or gold).
4. (c) Real exchange rate
The real exchange rate is the exchange rate after deducting an inflation
factor.
5. (b) Nominal exchange rate
The nominal exchange rate is the exchange rate before deducting an
inflation factor.
6. (d) Depreciation
Depreciation refers to a drop in the foreign exchange value of a
floating currency.
7. (c) Appreciation
Appreciation refers to a gain in the foreign exchange value of a floating
currency.

21
Block 2: Global Markets and Institutions

8. (d) Bretton Woods Agreement

Under the provisions of the Bretton Woods Agreement that was signed
in 1944, the governments of all the member countries took a pledge for
maintaining a fixed or pegged exchange rate for its currency vis-à-vis
gold or the dollar.
9. (c) Fixed-rate system
Under a fixed-rate system, governments can buy or sell their currencies
in the foreign exchange market whenever there is a deviation in the
stated par values.
10. (d) Crawling peg
The crawling peg is an automatic system for revising the exchange rate,
establishing a par value around which the rate can vary up to a given
percentage point.
11. (d) Target-zone arrangement
Target-zone arrangement is virtually a joint float system cooperatively
arranged by a group of nations sharing common interests and goals.
12. (a) Independent float system
In an independent float system, an exchange rate is allowed to freely
adjust to the demand and supply of this currency for another.
13. (b) Purchasing power parity
The purchasing power parity (PPP) principle states that in the long run,
the exchange rate between two currencies should reflect differences in
purchasing power, that is, the exchange rate should equalize the price of
identical goods and services in two countries.
14. (c) Interest rate parity
The Interest Rate Parity principle suggests that the difference in national
interest rates for securities of similar risk and maturity should be equal
to, but opposite in sign of, the forward rate discount or premium for the
foreign currency.
15. (d) Balance of Payments
The balance of payments is an accounting statement that summarizes all
the economic transactions between residents (individuals, companies,
and other organizations) of the home country and other countries.

22
 Unit 5
Foreign Exchange Markets
Structure
5.1 Introduction
5.2 Objectives
5.3 International Foreign Exchange Markets
5.4 International Capital Markets
5.5 Asian Financial Crisis
5.6 Summary
5.7 Glossary
5.8 Self-Assessment Test
5.9 Suggested Readings/Reference Material
5.10 Answers to Check Your Progress Questions

A nation's exchange rate is the single most important price in its economy; it
will influence the entire range of individual prices, imports and exports, and
even the level of economic activity. So it is hard for any government to ignore
large swings in its exchange rate.
- Paul Volcker

5.1 Introduction
The previous unit discussed the history of the international monetary system. It
then discussed different exchange rate systems. It then discussed the methods that
help in determining foreign exchange rates. The unit finally discussed the concept
of balance of payments and its accounts.
International monetary system and international financial markets are inherently
linked such that the former impacts the operations of a firm or company decisions
through the latter. International financial markets are composed of international
foreign exchange markets and international capital markets.
The Asian financial crisis illustrates how a financial crisis is reflected
simultaneously in the international foreign exchange markets and international
capital markets.
This unit will discuss different concepts in international foreign exchange rate
markets. It then goes into explaining the different international capital markets. It
finally discusses the three perspectives that highlight the causes for the Asian
financial crisis.
Block 2: Global Markets and Institutions

5.2 Objectives
By the end of this unit, students should be able to:
 Discuss various concepts of international foreign exchange markets.
 Narrate different international capital markets.
 Explain the causes for Asian financial crisis from financial,
political/institutional, and managerial perspective.

5.3 International Foreign Exchange Markets

5.3.1 Background of the International Foreign Exchange Market
A foreign exchange market is where foreign currencies can be bought and sold. It
is the institutional and physical structure through which currency exchange takes
place, exchange rates are determined, and foreign exchange transactions are
completed. A foreign exchange transaction is “an agreement between a buyer and
seller for the delivery of certain amount of one currency at a specified rate in
exchange for some other currency.” The US dollar was the most actively traded
currency. The second and third most traded currencies were deutsche mark and
Japanese yen, respectively.
The global foreign exchange business is concentrated in four centers – London,
New York, Tokyo, and Singapore. Other important foreign exchange markets are
located in Paris, Amsterdam, Zurich, Frankfurt, Toronto, Hong Kong, Milan,
Bahrain, and Brussels. The foreign exchange market is dominated by dealers, and
is becoming increasingly concentrated and automated.
5.3.2 Participants and Functions
The foreign exchange market includes individuals, banks, corporations, and
brokers who buy or sell currencies. The foreign exchange brokers intermediate to
conduct currency trading in each country, match currency bids and offers of banks
and also trade directly among themselves internationally. Banks throughout the
world are linked by telephone, telex, Internet, and satellite communications
network called the Society for World-wide International Financial
Telecommunications (SWIFT) based in Brussels, Belgium.
Though the market is global, the exchange market in each country has its own
identity and regulatory and institutional framework. An efficient communication
system can substitute for the need of participants to convene in some specific
location (bourse). Indeed, the US-UK type of market is based on communication
networks, whereas the European approach is traditional where the participants
meet physically at the bourse. Daily meetings take place in some markets such as
Paris and Frankfurt, where representatives of central banks and commercial banks
meet and determine a fixing rate. In those countries, the posted fixed rate acts as
guide for pricing small and medium- sized transactions between banks and their
customers. Major industrial countries such as Italy, Belgium, France, Japan, and

24
 Unit 5: Foreign Exchange Markets

the Benelux and Scandinavian countries have a daily fixing. The US, the UK,
Canada, and Switzerland do not have a daily fixing.
Foreign exchange trades in a 24-hour market. As the market in the Far East closes,
trading in the Middle East financial centers begins for a couple of hours, and then
trading in Europe begins. As the London market closes, the New York market
opens. After a few hours, the market in San Francisco opens and trades with the
Far East and the East Coast of the US. The foreign exchange market is dominated
by banks with about 90 percent of foreign-exchange trading comprising interbank
trading. Nonbank participants in foreign-exchange trading include multinational
corporations, commodities dealers, and nonbank financial institutions.
The three major functions performed by foreign exchange market are described
below:
1. It is part of the internationals payment system and offers a mechanism for
exchange or transfer of the national currency of a country into currency of
another country, thus facilitating international business.
2. Its assists in supplying credits those are of short-term through swap
arrangements and the Eurocurrency market.
3. It offers foreign-exchange instruments to hedge against risk.
Foreign-exchange trading sharply expanded under the floating exchange rate
system and the number of banks participating in the market significantly increased
as they entered the market for servicing their corporate clients. Increased hedging
by companies of their balance sheets and cash flows was accompanied by the
entry of new corporate participants in the market.
5.3.3 Foreign Exchange Rate Quotations
A foreign exchange rate quotation is “the expression of willingness to buy or sell
at a set rate.” In foreign exchange businesses, several pairs of quotations are used.
Quotations can either be in European terms or in American terms. European
quotes are given as number of units of a currency per US dollar. For instance,
CHF 0.93 per USD, EUR 0.91 per USD are quotes in European terms. In
American terms, quotes can be given as number of US dollars per unit of a
currency. For instance, USD 1.07per CHF and USD 1.30per GBP are quotes in
American terms.
Direct and Indirect
We often come across terminology such as direct quote and indirect quote. In a
country, direct quotes are “those that give units of the currency of that country per
unit of a foreign currency.” Thus INR 76 per USD is a direct quote in India and
USD 1.90 per EUR is a direct quote in the US. Indirect quotes or reciprocal quotes
are stated “as number of units of a foreign currency per unit of the home
currency.” Thus USD 0.013 per INR is an indirect quote in India. Similarly for
currencies like Italian lira or Japanese yen, quotations may be in terms of 100 lira

25
Block 2: Global Markets and Institutions

or 1000 yens. In the foreign exchange activities, US banks adhere to the European
method of direct quotation.
Bid and Offer
Banks usually do not charge a commission on their currency transactions. They
profit from the spread between the buying and selling rates. Quotes are given in
pairs always because the dealer usually does not know whether a prospective
customer is in the market to buy or to sell a foreign currency. The first rate is the
buy or bid, price. The second rate is the sell, ask, or offer. For instance, if a pound
sterling is quoted at $ 1.7019-36, the quote means that the banks are willing to
buy pounds at $ 1.7019 and sell them at $ 1.7036. In practice, the dealers quote
only the last two digits of the decimal. In the above example, sterling would be
quoted as 19-36.
The bid-ask spread i.e. “the spread between bid and ask rates for a currency is
based on the breadth and depth of the market for that currency as well as
currency’s volatility. The bid-ask spread is usually stated as a percentage cost of
transacting in
Ask price – Bid price
Percent spread = X 100
Ask price

For instance, if the pound sterling quoted at $1.7019-36, the percentage spread
equals 0.1%.
1.7036 - 1.7019
Percent spread = = 0.1%
1.7036
Widely traded currencies such as the pound, yen, the spread might be on the order
of 0.1 to 0.5%. less heavily traded currencies have higher spreads.
Spot and Forward
Spot rate and forward rate is used for foreign exchange transactions between
dealers in the interbank market. A spot rate is “the exchange rate for a transaction
that requires almost immediate delivery of foreign exchange.” A forward rate is
“the exchange rate for a transaction that requires delivery of foreign exchange at
specified future date (e.g. 30-day, 90-day or 180-day).”

Example
As per the ET dated 29th January 2022, the spot rate of USD/ INR is 75.04 and
the forward rates of USD / INR for the next three months are as follows
28.02.22- ₹ 75.240
31.03.22- ₹ 75.525
30.04.22- ₹ 75.915
Contd….

26
 Unit 5: Foreign Exchange Markets

Banks have fixed the forward rates based on certain criteria between the
constituents of the forex market. The constituent is ‘between forex dealers’ to
whom these rates apply to.
Source: ICFAI Research Center

Cross Rates
The cross rate is “the exchange rate between two infrequently traded currencies,
calculated through a widely traded third currency.” For instance, an importer in
Argentina needs the Hong Kong dollar for paying a purchase in Hong Kong. The
Argentinean peso is not quoted against the Hong Kong dollar. On the other hand,
both the currencies are quoted against the US dollar. Suppose:
Argentina Peso: ARS 112.95/US$1 Hong Kong Dollar: HKD 7.83939 HKD/
US$1
Cross rates between Argentina Peso and Hong Kong Dollar: ARS 112.95/7.83939
= ARS 14.08/HKD
or HKD 7.83939/ARS 112.95 = HKD 0.0694/ARS
As most currencies are quoted against the dollar, it might be necessary to work
out the cross-rates for currencies other than dollars. For instance, if the Deutsche
mark is selling for $0.30 and the buying rate for the French franc is $0.075, then
the DM/FF cross-rate is DM 1= FF4.

Activity 5.1
William Jack, an Argentine importer needs a Hong Kong dollar to pay for a
purchase in Hong Kong. The Argentinean peso is not quoted against the Hong
Kong dollar. Both currencies are quoted against the US dollar. Identify the
foreign exchange rate quotation. Also discuss other foreign exchange rate
quotations.

5.3.4 Transaction Forms

Spot Transactions
Spot transactions include spot transactions between banks and bank notes
transactions for individuals. Spot transactions are usually settled on the second
working day on which the transaction concludes. Bank notes transactions include
currency changes for individuals that are exchanged for each other
instantaneously over the counter. The largest financial market in the world is

27
Block 2: Global Markets and Institutions

interbank foreign exchange. On the settlement date, most dollar transactions in

the world are settled through the computerized Clearing House Interbank
Payments Systems (CHIPS) in New York, which provides for calculating new
balances owed by any one bank to another and for payment the same day in
Federal Reserve of New York funds.
When an individual or a company needs foreign exchange to be paid for a foreign
company, it can either use international wire transfers or customer drafts. Under
a wire transfer, the payment instructions are sent through SWIFT or other
electronic means. The bank sells this individual or company a foreign exchange
draft that is payable to the stated foreign company.
Forward Transactions
A forward transaction occurs “between a bank and a customer calling for delivery
at a fixed future rate, of a specified amount of foreign exchange at the fixed
forward exchange rate.” The exchange rate is set at the time of the agreement, but
until maturity, payment and delivery is not required. International companies may
either buy a foreign currency forward from a bank or sell a foreign currency
forward to a bank. The position where the initial transaction represents an asset
or future ownership claim to foreign currency is termed as long position. The
position where the cash market position represents future obligation or liability to
deliver foreign currency is termed as short position.

Example
Mr. Rajeev Agarwal is one of the largest producers of groundnuts on his 500
acres farm near Bhavnagar in Gujarat. He obtains an export order from
Senanayike Oil mills (SOM), Galle Sri Lanka to sell 5,000 tonnes of the
produce six months from 01.01.2022. Rajeev Agarwal enters into a forward
contract with his banker, as he is concerned about a potential decline in the
exchange rates. Here the Bank and Mr. Agrawal set the exchange rate for the
transaction at the time of agreement.
Source: ICFAI Research Center

Swap Transactions
A swap is “an agreement to buy and sell foreign exchange at prespecified
exchange rates where the buying and selling are separated in time.” A swap
transaction involves simultaneous sale and purchase of a given amount for two
different dates of settlement. A same counter-party carries out both sale and
purchase. Swap transactions are of two types –spot forward swap and forward-
forward swap.
In a spot-forward swap, “an investor sells forward the foreign currency maturity
value of the bill, and simultaneously buys the spot foreign exchange to pay for the
bill.” Because a known amount of the home currency of the investor will be

28
 Unit 5: Foreign Exchange Markets

received according to forward swap component, no uncertainty would exist from

exchange rates. Similarly, those borrowing in foreign currency can buy forward
the foreign currency essential for repaying foreign currency loan at the same time
as they convert the foreign funds that are borrowed on the spot market.
A forward-forward swap involves two forward transactions. For instance, a dealer
sells Euro 1,000,000 forward for dollars for delivery in three months at US$
0.94/Euro, and simultaneously buys Euro 1,000,000 forward for delivery in six
months a2t6US$ 0.94/Euro.
The two preceding swaps are popular with banks as it is difficult to avoid them
when making a market for future currencies and dates.

Example
As per a report in ET dated 1st July 2019, many large Indian banks have sought
RBI’s intervention about the sharp increase in hedging cost of corporates as
banks are finding it difficult to handle surplus dollar. Many companies have
borrowed foreign currency and exchanged for INR in Banks since foreign
currency swap deals and diluted norms on Forex borrowings of RBI had
encouraged many corporates to step up their foreign currency borrowings to
hedge their risks due to currency fluctuations. However the difference between
the interest on dollar and the interest on rupee which the corporate is required
to pay at a later date was putting stress on their finances.
Source: ICFAI Research Center

5.3.5 Foreign Exchange Arbitrage

In the foreign exchange market, the information related to price is easily available
through computer networks, which makes it easier for price comparison in other
markets. As such, exchange rates tend to equal worldwide but temporary
discrepancies do exist. These discrepancies offer profit opportunities for buying
a currency in one market while simultaneously selling it in another. This activity
is called as arbitrage. It continues until the exchange rates in different locales are
so close that it is not worth the costs incurred in additional buying and selling.

Example
As per a report in ET dated 19th September 2019, there is a sharp increase in
imports in oil market as India imports 75 % of its oil needs via overseas
shipments. Due to volatility in crude price, there is a sharp movement in in the
local currency against the dollar. There has been a continuous rise in onshore
forwards premium in the past one month and forwards premium rose to 4.42
per cent from 4.03 per cent leading to an arbitrage. This has prompted traders
to borrow dollars overseas, and sell them in the local markets thereby making
a profit of almost a quarter rupee / $ between offshore and onshore forwards.
Source: ICFAI Research Center

29
Block 2: Global Markets and Institutions

5.3.6 Black Market and Parallel Market

Due to legal prohibitions or government restrictions on foreign exchange
transactions, illegal markets in foreign exchange exist in many developing
countries in response to private or business demand for foreign exchange. These
illegal markets are known as black markets. The illegal markets exist openly in
some countries (e.g. Venezuela and Brazil) where interference of government is
very little. However, in some other countries, foreign exchange laws are enforced
strictly and lawbreakers when caught receive harsh sentences (e.g. China before
1985).
Often, governments set an official exchange rate that widely deviates from the
one established by the free market. If the government wishes to purchases foreign
exchange at the official rate, but private citizens wish to pay the market-
determined rate, there would be steady supply of foreign exchange to the black
market. Thus it can be inferred that government policy creates a black market.
The demand arises due to legal restrictions on buying foreign exchange, and the
supply exists because official exchanges that are mandated by governments offer
less than the free market rate. Ironically, governments defend the need for
restrictions on foreign exchange based on conserving scarce foreign exchange
that flows to the government as traders may instead to black market.
The black market when legalized by the government is referred to as parallel
market. It operates as an alternative to the official exchange rate. In countries
facing economic hardship, the parallel markets allow continuation of normal
economic activities through a steady supply of foreign exchange.

5.4 International Capital Markets

5.4.1 International Monetary Markets
International money markets are markets where foreign monies are invested or
financed. MNEs make use of international money markets for financing global
operations at a lower cost than is possible in domestic markets. The MNEs borrow
currencies having lower interest rates and are expected to depreciate against their
own currency. However, they incur the risk that the borrowed currencies may
appreciate, which increases their cost of financing. On the other hand, investors
may substantially achieve higher returns in foreign markets than in their domestic
markets when they invest in currencies that appreciate against their home country.
If the currencies depreciate, however, the effective yield on foreign investments
would be lower than the domestic yield, and may be even negative. Investors
make attempts to capitalize on potentially high effective yields on foreign market
securities, while reducing the exchange rate risk by diversifying investments
across currencies.
Often transactions in the international money markets take place through
Eurocurrency market. The Eurocurrency market comprises commercial banks that
offer large loans in foreign currencies and accept large deposits. The banks

30
 Unit 5: Foreign Exchange Markets

offering Eurocurrency services are either local banks or subsidiaries foreign banks
in a host country. The growth of the Eurocurrency market is attributed to growing
international trade and capital flows as well as cross-border differences in interest
rates. In this market, Eurodollar deposits are transacted intensively.
Eurodollars are US dollar deposits in non-US banks. Eurodollar deposits are not
subject to reserve requirements and hence banks can lend out 100 percent of
deposits. Loan transactions and deposits on Eurodollars are usually US$ 1 million
or more per transaction.
Two popular Eurodollar deposits are Eurodollar fixed-rate certificate of deposits
(CDs) and Eurodollar floating-rate certificate of deposits. The fixed-rate
Eurodollar CDs are adversely affected by the rising market interest rates but they
receive guaranteed interest. This problem is neutralized by the floating-rate
Eurodollar CDs that offer the rate that can be adjusted periodically to the London
Interbank Offer Rate (LIBOR) – the rate charged on interbank loans.
5.4.2 International Bond Markets
International bond markets are the markets where corporate bonds or government
bonds are issued, bought, or sold in foreign countries. The growth of these markets
is attributed to some unique features that are offered by international bonds which
are not offered by domestic bonds. The development of the international bond
market is attributed to tax law differentials across countries. In 1984, the
elimination of withholding tax on US-placed bonds caused a large increase in the
foreign demand for US-placed bonds.

Example
As per a news reported in Business Standard dated 25th July 2019, Government
of India is planning to raise $ 10 billion debt from international market through
yen or euro-denominated debt over a long period. The reason for such an
offering is that interest rate in yen is low. The report also mentioned that there
is a possibility of offering dollar denominate debt as well to improve its
liquidity.
Source: ICFAI Research Center

Bonds placed in international bond markets are typically underwritten by an

association of investment banking firms. Many underwriters in the Eurobond
market, which is a market where bonds issued in one foreign currency are issued
in the country using that currency, are US bank subsidiaries that have focused
their growth on non-US countries since they were banned historically by the
Glass-Steagall Act from underwriting corporate bonds in the US.
5.4.3 International Stock Markets
International stock or equity markets are markets where company stocks are listed
and traded on foreign stock exchanges. Firms in need of finance make use of

31
Block 2: Global Markets and Institutions

foreign stock exchanges as additional sources of funds. Foreign stock markets are
used by investors for enhancing the performance of their portfolio. This source
of financing allows MNEs to attract more funds without flooding their home
stock market thus circumventing the decline in share price. Many MNEs also
issue stock in foreign markets for circumventing regulations as regulatory
provisions differ among markets. Firms believe that by issuing stock in foreign
markets, they can achieve worldwide recognition among consumers. Further,
listing stock on a foreign stock exchange enhances the liquidity of the stock but
also increases the perceived financial standing of the firm when the exchange
approves the listing application. It also protects firms against hostile takeovers
as it disperses ownership and makes it difficult for other firms to gain a
controlling interest.
The Euroequity market is a market where US dollar-denominated stocks are
issued on non-US exchanges. This market has grown and developed since the
1980s. the stock issued in the Euroequity market are designed specifically for
distribution among foreign markets. They are underwritten by an association of
investment banks and purchased chiefly by institutional investors in several
countries.
The firms‟ ability to place new shares in foreign markets partially depends on the
perceived liquidity of the stock in that market. To enhance liquidity and make
newly issued stocks attractive, a secondary market should be established in
foreign markets.
5.4.4 International Loan Markets
International loan markets comprise large commercial banks and lending
institutions that offer loans to foreign companies. Loan markets are not restricted
only to foreign currency transactions, unlike international money markets that
have dealings only with foreign money. As regulations across the US, Europe,
and Japan have standardized, the markets for loans and other services become
globalized. Thus some financial institutions make attempts to achieve greater
economies of scale on the services offered by them. Even financial institutions
that do not plan global expansion experience increased foreign competition in
their home markets.
International lending is perceived as a means of diversification by banks from all
countries. International lending also allows banks to develop relationships with
foreign firms, which create a demand for other services offered by the bank. In
addition, a major portion of international lending is to support international
acquisitions. Investment banks and commercial banks serve as advisers as well as
financial intermediaries by providing loans or by placing stocks and bonds. A
common form of participation has been to offer direct loans to finance
acquisitions, especially for leveraged buyouts (LBOs) by management or other

32
 Unit 5: Foreign Exchange Markets

investor groups. Since LBOs mostly are financed through debt, they result in a
large demand for loanable funds. Most of the LBOs are supported by debt from
an international syndicate of banks. In this way, each bank limits its exposure to
a particular borrower. As the firms engaged in LBOs are from diversified
industries, a problem in any industry does not lead to a lending crisis. In addition,
the debt of each individual firm is relatively small so that many borrowers do not
access to sufficient bargaining power for rescheduling their debt payments. For
this reason, international bank financing of LBOs is considered to be less risky
than offering loans to government of developing countries.
Lending to developing countries requires credit checking. International
commercial banks and other lending institutions carry out credit checking based
on an analysis by credit rating agencies such as Moody’s and Standard and Poor’s.
The focus of analysis is on political risks and overall pressures on the balance of
payments and macroeconomic conditions.

Activity 5.2
ABC Automobiles Ltd., a Japanese automaker is one the leading players in the
Japanese auto market. The company planned to expand its operations in
Germany, China and India. The company borrowed funds from several banks
in Japan but the funds were insufficient to finance its expansion plans. Thus the
company borrowed money from US banks in Tokyo. In this context, identify
and define the international capital market. Also discuss other international
capital markets.

5.5 Asian Financial Crisis

The Asian financial crisis depicts how a crisis should take place in international
financial markets and how the crisis relates international financial markets,
financial institutions, and the governments. The Asian financial crisis had first
afflicted Thailand in June 1997, which then quickly spread to the Philippines,
Indonesia, Malaysia, South Korea, and other Southeast and East Asian countries.
Initially, the crisis took the form of a financial meltdown, with stock markets,
currencies, and property prices dropping across the region. Economic aftershocks
ensued. The crisis was soon to have its affect on markets and economies across
the world from Europe to Latin America. The nations of East and Southeast Asia
familiarized with high single or double digit growth rates shifted to sluggish and
negative growth. These poor economic conditions prevailed in most of these
nations until early 1999.

33
Block 2: Global Markets and Institutions

5.5.1 The Financial Perspective

According to the financial perspective, the Asian financial crisis resulted
primarily due to weakness of the financial sector and market failure. Two factors
stand-out for contributing to the financial sector weakness and market failure from
the financial perspective. The first is the maintenance of the pegged exchange
rates that were viewed as implicit guarantees of exchange that constrained
monetary remedies. The second is excessive private sector short-term and dollar-
denominated borrowing.
Additionally, the financial perspective emphasizes the effects of contagion on the
crisis. Contagion fueled the crisis through the wake-up effect and the dynamics of
competitive devaluation. The former explains the tendency of most of the foreign
investors to treat all Asian countries as one and pull out investments from a
country regardless of its market and economic fundamentals and the latter pertains
to the pressure faced by Asian countries for devaluing their currency to match
devaluation by neighboring countries.
5.5.2 The Political/Institutional Perspective
According to political/institutional-based explanations, the causes of Asian crisis
extend beyond weaknesses in the financial sector and market failure. The political
and institutional perspectives point to irresponsible domestic governance,
corruption in the public and private sectors, crony capitalism, weak national and
political institutions, misguided and poorly enforced regulatory environment, and
other political and institutional-related factors as the principal forces behind the
crisis.
The crisis highlighted key weaknesses in the institutions and political/economic
systems of several Asian countries. The prevalent practice of crony capitalism in
countries such as Malaysia, Thailand, and Indonesia led to an overextension of
credit to undeserving companies with close ties to the military and political
leadership. Due to conflicting business interests, politicians and government
bureaucrats have been very ineffective in responding to the crisis.
The IMF noted three political and institutional-related considerations as forces
contributing to the Asian financial crisis:
 In financial systems, lax enforcement of providential rules and inadequate
supervision, weak management and poor control of risks, and government
direct lending practices resulted in sharp deterioration of loan portfolios of
banks.
 Lack of transparency and problems of data availability hindered market
participants from maintaining a realistic view of economic fundamentals, and
also added to uncertainty.
 Political uncertainties and governance problems aggravated the crisis of
confidence, the downward pressure on currencies and stock markets, and the
reluctance of foreign creditors to roll over short-term loans.

34
 Unit 5: Foreign Exchange Markets

5.5.3 The Managerial Perspective

The third group of explanations advocates that micro-management was at the
heart of the crisis. The booming economy of the 1990s encouraged many
industrial companies in East and Southeast Asia to pursue risky over
diversification. These companies relied on short-term debt financing to fund their
expansion. For instance, the ”chaebols‟ or the five largest conglomerates of South
Korea (i.e. Samsung, Hyundai Motor, Lucky Goldstar, SK, and Kia contributed
heavily to the GDP of South Korea .
Over diversification and extended leveraging led to the creation of a vicious cycle
for many companies. Firms pursued risky ventures to service their expensive,
short-term debt and earn large returns on their investment. When these risky
projects failed, the firms borrowed more to keep their operations afloat. These
companies maintained this practice until the banks were willing to extend their
credit. When the financial crisis hit, the banks refused to extend their credit and
this forced many firms into bankruptcy.
The problems for these firms were compounded by contracting export markets,
falling commodity prices, and other external pressures. Instead of addressing
these external pressures by cutting costs, improving productivity, and focusing on
the bottom line, majority of the firms opted for growth and diversification into
unrelated businesses. This strategy proved costly when the financial crisis hit and
dried up the funds. In contrast, firms focusing on their core competencies – cutting
costs, enhanced productivity, and focused on profitability were able to weather
the storm.
Financial institutions and banks extended their credit to undeserving companies.
When those companies could not repay, banks rolled over their loans and
extended their credit. The financial perspective views the process as a market
failure while the political/institutional perspective blames to overextended credit.
The managerial perspective attributes such credit overextension to lack of
sophistication in management and absence of administrative apparatus for
conducting proper analysis and oversight.

Check Your Progress - 1

1. A is an agreement between a buyer and seller for the

delivery of certain amount of one currency at a specified rate in exchange for
some other currency.
a. International stock market transaction
b. Foreign exchange transaction
c. Domestic exchange transaction
d. None of the above

35
Block 2: Global Markets and Institutions

2. those that give units of the currency of that country per

unit of a foreign currency.
a. Indirect quotes
b. Direct quotes
c. Bid
d. Offer
3. are stated as number of units of a foreign currency per
unit of the home currency.
a. Direct quotes
b. Offer
c. Bid
d. Indirect quotes
4. A is the exchange rate for a transaction that requires almost
immediate delivery of foreign exchange.
a. Forward rate
b. Spot rate
c. Swap rate
d. None of the above
5. A is the exchange rate for a transaction that requires delivery
of foreign exchange at specified future date.
a. Swap rate
b. Spot rate
c. Forward rate
d. indirect quote
6. The is the exchange rate between two infrequently traded
currencies, calculated through a widely traded third currency.
a. Forward rate
b. Cross rate
c. Spot rate
d. None of the above
7. include spot transactions between banks and bank notes
transactions for individuals.
a. Spot transactions
b. Swap transactions
c. Forward transactions
d. None of the above

36
 Unit 5: Foreign Exchange Markets

8. A occurs between a bank and a customer calling for delivery at a fixed

future rate, of a specified amount of foreign exchange at the fixed forward
exchange rate. swap
a. Transactions forward
b. Transactions spot
c. Transactions
d. None of the above
9. A is an agreement to buy and sell foreign exchange at prespecified
exchange rates where the buying and selling are separated in time.
a. Swap
b. Forward
c. Spot
d. Black market
10. The illegal markets in foreign exchange markets are known as .
a. Parallel market
b. Black market
c. Primary market
d. Secondary market
11. The black market when legalized by the government is referred to as .
a. Black market
b. Parallel market
c. Primary market
d. Secondary market
12. comprise large commercial banks and lending
institutions that offer loans to foreign companies.
a. International stock markets
b. International loan markets
c. International money markets
d. International bond markets
13. are markets where foreign monies are invested
or financed.
a. International bond markets
b. International loan markets
c. International money markets
d. International stock markets

37
Block 2: Global Markets and Institutions

14. Often transactions in the take place through Eurocurrency market.

a. International stock markets
b. International money markets
c. International bond markets
d. None of the above
15. The are adversely affected by the rising market interest rates
but they receive guaranteed interest.
a. Eurodollar fixed-rate CDs
b. Eurodollar floating-rate CDs
c. international money markets
d. None of the above
16. The offer the rate that can be adjusted periodically to the
London Interbank Offer Rate.
a. Eurocurrency market
b. Eurodollar floating-rate CDs
c. international stock markets
d. Eurodollar fixed-rate CDs
17. are the markets where corporate bonds or
government bonds are issued, bought, or sold in foreign countries.
a. International stock markets
b. International bond markets
c. International money markets
d. International loan markets
18. are markets where company stocks are listed
and traded on foreign stock exchanges.
a. International stock markets
b. International loan markets
c. International bond markets
d. International money markets
19. The is a market where US dollar-denominated stocks are
issued on non-US exchanges.
a. Eurocurrency market
b. Euroequity market
c. Eurodollar market
d. None of the above

38
 Unit 5: Foreign Exchange Markets

20. The causes of Asian financial crisis can be understood from which of the
following perspectives?
i. Economic perspective
ii. Managerial perspective
iii. Political/institutional perspective
iv. Social perspective
v. Financial perspective
a. i, ii, and v
b. ii, iii, and iv
c. i, iii, and iv
d. ii, iii, and v
21. According to which perspective, the Asian financial crisis resulted primarily
due to weakness of the financial sector and market failure?
a. Managerial perspective
b. Economic perspective
c. Political perspective
d. Financial perspective
22. The emphasizes the effects of contagion on the Asian financial crisis.
a. Financial perspective
b. Market perspective
c. Institutional perspective
d. Managerial perspective
23. The perspectives point to irresponsible domestic governance,
corruption in the public and private sectors, crony capitalism, weak national
and political institutions, and misguided and poorly enforced regulatory
environment as causes for the Asian financial crisis.
a. Managerial perspective
b. Political/institutional perspective
c. Financial perspective
d. None of the above
24. The attributes such credit overextension to lack of
sophistication in management and absence of administrative apparatus for
conducting proper analysis and oversight as causes for the Asian financial
crisis.
a. Financial perspective
b. Political/institutional perspective
c. Managerial perspective
d. Economic perspective

39
Block 2: Global Markets and Institutions

5.6 Summary
 A foreign exchange transaction is an agreement between a buyer and seller
for the delivery of certain amount of one currency at a specified rate in
exchange for some other currency.
 The foreign exchange market includes individuals, banks, corporations, and
brokers who buy or sell currencies.
 International money markets are markets where foreign monies are invested
or financed.
 International bond markets are the markets where corporate bonds or
government bonds are issued, bought, or sold in foreign countries.
 International stock or equity markets are markets where company stocks are
listed and traded on foreign stock exchanges.
 International loan markets comprise large commercial banks and lending
institutions that offer loans to foreign companies.
 The Asian financial crisis depicts how a crisis should take place in
international financial markets and how the crisis relates international
financial markets, financial institutions, and the governments.

5.7 Glossary
Eurobond market: Eurobond market is a market where bonds issued in one
foreign currency are issued in the country using that currency.
Eurocurrency market: The Eurocurrency market comprises commercial banks
that offer large loans in foreign currencies and accept large deposits.
Eurodollars: Eurodollars are US dollar deposits in non-US banks.
Euroequity market: The Euroequity market is a market where US dollar-
denominated stocks are issued on non-US exchanges.
Foreign exchange transaction: A foreign exchange transaction is an agreement
between a buyer and seller for the delivery of certain amount of one currency at a
specified rate in exchange for some other currency.
Foreign exchange rate quotation: A foreign exchange rate quotation is the
expression of willingness to buy or sell at a set rate.
International bond markets: International bond markets are the markets where
corporate bonds or government bonds are issued, bought, or sold in foreign
countries.
International loan markets: International loan markets comprise large
commercial banks and lending institutions that offer loans to foreign companies.
International money markets: International money markets are markets where
foreign monies are invested or financed.
International stock: International stock or equity markets are markets where
company stocks are listed and traded on foreign stock exchanges.

40
 Unit 5: Foreign Exchange Markets

5.8 Self-Assessment Test

1. Define a foreign exchange transaction. List the participants in the foreign
exchange market. Also state the functions of the foreign exchange market.
2. Describe different foreign exchange rate quotations.
3. Briefly describe the various transaction forms.
4. Define black market and parallel market.
5. Briefly explain the various international capital markets.
6. The causes of Asian financial crisis fall into three broad perspectives –
financial, political/institutional, and managerial. Explain these perspectives
in detail.

5.9 Suggested Readings/Reference Material

1. Charles W L Hill and G Thomas M Hult (2021). International Business –
Competing in the Global Marketplace. 12th edition, McGraw Hill India.
2. Oded Shenkar, Yadong Luo, Tailan Chi (2021). International Business, 4th
edition, Routledge
3. Alan C Shapiro (2019). Multinational Financial Management, 11th Edition,
Wiley
4. Prakash G Apte (2017). International Financial Management, 8th edition,
McGraw-Hill India
5. H.G.Mannu (2018). International Economics. Vikas Publishing House
6. Francis Cheunilam (2020). International Business – Text and Cases. 6th
edition. Prentice Hall India Learning Private Limited
7. John Wild and Kenneth Wild (2019). International Business – The Challenges
of Globalization. Pearson Education
Additional References:
1. Serenity Gibbons. How to expand your business internationally without
compromising your core model. Forbes (2020).
https://www.forbes.com/sites/serenitygibbons/2020/03/24/how-to-expand-a-
business-internationally-without-compromising-your-core-
model/?sh=66335a6f741d
2. IFRS Foundation. Use of IFRS standards around the world. 2018.
https://cdn.ifrs.org/-/media/feature/around-the-world/adoption/use-of-ifrs-
around-the-world-overview-sept-2018.pdf
3. Brett Steenbarger. Why diversity matters in the world of Finance. 2020.
https://www.forbes.com/sites/brettsteenbarger/2020/06/15/why-diversity-
matters-in-the-world-of-finance/?sh=36dba0637913

41
Block 2: Global Markets and Institutions

4. IFC. Social and Green Bonds.

https://www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corpor
ate_site/about+ifc_new/investor+relations/ir-products/socialbonds
5. Business Insider. Global ecommerce market report: ecommerce sales trends
and growth statistics for 2021. https://www.businessinsider.com/global-
ecommerce-2020-report?IR=T

5.10 Answers to Check Your Progress Questions

1. (b) Foreign exchange transaction
A foreign exchange transaction is an agreement between a buyer and
seller for the delivery of certain amount of one currency at a specified
rate in exchange for some other currency.
2. (b) Direct quotes
Direct quotes are those that give units of the currency of that country per
unit of a foreign currency.
3. (d) Indirect quotes
Indirect quotes are stated as as number of units of a foreign currency per
unit of the home currency.
4. (b) Spot rate
A spot rate is the exchange rate for a transaction that requires almost
immediate delivery of foreign exchange.
5. (c) Forward rate
A forward rate is the exchange rate for a transaction that requires
delivery of foreign exchange at specified future date.
6. (b) Cross rate
The cross rate is the exchange rate between two infrequently traded
currencies, calculated through a widely traded third currency.
7. (a) Spot transaction
Spot transactions include spot transactions between banks and bank
notes transactions for individuals.
8. (b) Forward transaction
A forward transaction occurs between a bank and a customer calling for
delivery at a fixed future rate, of a specified amount of foreign exchange
at the fixed forward exchange rate.
9. (a) Swap
A swap is an agreement to buy and sell foreign exchange at prespecified
exchange rates where the buying and selling are separated in time.

42
 Unit 5: Foreign Exchange Markets

10. (b) Black market

The illegal markets in foreign exchange markets are known as black
markets.
11. (b) Parallel market
The black market when legalized by the government is referred to as
parallel market.
12. (b) International loan markets
International loan markets comprise large commercial banks and lending
institutions that offer loans to foreign companies.
13. (c) International money markets
International money markets are markets where foreign monies are
invested or financed.
14. (b) International money markets
Often transactions in the international money markets take place through
Eurocurrency market.
15. (a) Eurodollar fixed-rate CDs
The fixed-rate Eurodollar CDs are adversely affected by the rising
market interest rates but they receive guaranteed interest.
16. (b) Eurodollar floating-rate CDs
The floating-rate Eurodollar CDs offer the rate that can be adjusted
periodically to the London Interbank Offer Rate.
17. (b) International bond markets
International bond markets are the markets where corporate bonds or
government bonds are issued, bought, or sold in foreign countries.
18. (a) International stock markets
International stock or equity markets are markets where company stocks
are listed and traded on foreign stock exchanges.
19. (b) Euroequity market
The Euroequity market is a market where US dollar-denominated stocks
are issued on non-US exchanges.
20. (d) ii, iii, and v
The causes of Asian financial crisis can be understood from financial,
political/institutional, and managerial perspectives.
21. (d) Financial perspective
According to the financial perspective, the Asian financial crisis resulted
primarily due to weakness of the financial sector and market failure.

43
Block 2: Global Markets and Institutions

22. (a) Financial perspective

The financial perspective emphasizes the effects of contagion on the
Asian financial crisis.
23. (b) Political/institutional perspective
The political/institutional perspectives point to irresponsible domestic
governance, corruption in the public and private sectors, crony
capitalism, weak national and political institutions, and misguided and
poorly enforced regulatory environment as causes for the Asian financial
crisis.
24. (c) Managerial perspective
The managerial perspective attributes such credit overextension to lack
of sophistication in management and absence of administrative
apparatus for conducting proper analysis and oversight as causes for the
Asian financial crisis.

44
 Unit 6
International Economic Integration and Institutions
Structure
6.1 Introduction
6.2 Objectives
6.3 International Economic Integration
6.4 Cooperation among Nations at the Global-level
6.5 Cooperation among Nations at the Regional-level
6.6 Cooperation among Nations at the Commodity-level
6.7 Strategic Responses of Multinational Enterprises
6.8 Summary
6.9 Glossary
6.8 Self-Assessment Test
6.9 Suggested Readings/Reference Material
6.10 Answers to Check Your Progress Questions

There are differences in the world community. But we have a common interest in
a strong multilateral system.
- Joschka Fischer (Former Vice Chancellor of Germany)

6.1 Introduction
The previous unit discussed different concepts in international foreign exchange
rate markets. It then explained the different international capital markets. It finally
discussed the three perspectives that highlight the causes for the Asian financial
crisis.
The International economic relations are governed by a variety of institutions and
treaties which have boosted economic integration and erased barriers to free trade,
service, and investment among nations. International economic integration is
propelled by three levels of cooperation – global, regional, or commodity. Global-
level cooperation occurs through international economic agreements or
organizations (e.g. WTO). Regional-level cooperation takes place through
common markets or unions (e.g. NAFTA), and commodity-level cooperation
takes place through multilateral commodity cartels or agreements (e.g. OPEC).
With the increasingly integrated environments, multinational enterprises have
also realigned their international strategies as they are a critical force in steering
international economic integration.
Block 2: Global Markets and Institutions

This unit will discuss the different forms of economic integration. It then goes
into explaining the three fundamental institutions affecting cooperation among
nations at the global level – the World Trade Organization, the International
Monetary Fund, and the World Bank. It then discusses different regional
agreements and international commodity agreements. It finally discusses the
strategic responses of multinational enterprises to regional economic integration.

6.2 Objectives
By the end of this unit, students should be able to:
 Describe the different forms of economic integration.
 State the different institutions affecting global-level cooperation.
 Discuss different regional agreements and international commodity
agreements.
 Explain the strategic responses of multinational enterprises to regional
economic integration.

6.3 International Economic Integration

Economic integration concerns removal of trade barriers or impediments between
at least two participating nations and establishing and coordinating between them.
Economic integration helps steer the world toward globalization. The following
forms of economic integration are implemented often:
Free trade area involves country combination, where the member nations remove
trade barriers among themselves while retaining their freedom related to policy
making vis-à-vis non-member countries. Examples of free trade area include
Latin American Free Trade Agreement and North American Free Trade
Agreement.
Customs union is identical to free trade area except that member nations must
pursue and conduct common external commercial relations like common tariff
policies on imports from non-member nations. Examples of this form include the
Caribbean Community and Common Market (CARICOM) and the Central
American Common Market (CACM).
Common market is a particular customs union that permits free trade of products
and services only but with free mobility of production factors across national
member borders. Example of this form is the Southern Common Market Treaty
(MERCOSUR).
Economic union is a particular common market that unifies fiscal and monetary
policies. The participants bring in a central authority for exercising control over
these matters so that member nations become an enlarged entity.
Political union requires participating nations to become one nation in a political
and economic sense. This union involves establishing a common parliament and
other political institutions.

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The above forms reflect economic integration between or among nations in a

region. Global economic integration also takes place through multilateral
cooperation in which nations who participate are bound by rules, responsibilities,
or principles which are stipulated in commonly agreed agreements. Multilateral
agreements promote worldwide economic exchanges. They may be designed for
governing general trade, investment, service, capital flows, financial market
stability, or specific areas of trade.
Economic integration generates economic gains for participating nations.
Production efficiency can be enhanced by increased specialization according to
the law of comparative advantage. The increased market size increases economies
of scale which in turn elevates the level of production. Further, the collective
bargaining power of the member nations increases against non-member nations.
This power lead to better terms of trade that is higher price on products exported
to non-participating countries and lower prices on imports from non-participating
countries. However, these gains are not guaranteed nor will each member country
benefit equally from integration. Free mobility of production factors may create
pressures on inflation rates, employment levels, income distribution, or trade
balance for nations that are in different economic stages or have a varying
dependence on the goods and services of other nations.

Activity 6.1
In December 1995, an agreement came into effect between Turkey and
European Union wherein goods could travel between two entities without any
restriction. Identify the form of economic integration. Also discuss other forms
of economic integration.
Answer:

6.4 Cooperation among Nations at the Global-Level

The three fundamental institutions affecting cooperation among nations at the
global level are the World Trade Organization, the International Monetary Fund,
and the World Bank. While the WTO serves as the institutional foundation of the
international trade system, the IMF and the World Bank serve as institutional
foundation of the international monetary and financial system.
6.4.1 The World Trade Organization (WTO)
Background and Structure
The World Trade Organization came into being on January 1, 1995 as a
multilateral trade organization that aimed at international liberalization of trade.

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It came as a successor to the General Agreement on Tariffs and Trade (GATT).

GATT was set up after the first round of tariff negotiations at the Geneva
conference held in 1947 on the proposed International Trade Organization (ITO).
After periodic rounds of multilateral negotiations on tariff cuts and non-tariff
reductions, GATT was evolved.
Prior to the Kennedy Round, early negotiations primarily dealt with reducing
tariffs. By the end of the Tokyo round in 1979, the need to confront increasing
usage of non-tariff barriers, especially by developed countries, led to the adoption
of number of codes that dealt with specific practices. The scope of GATT was
broadened in the Uruguay round where it reintroduced the idea of a
comprehensive international trade organization for coordinating international
economic activities.
The Uruguay Round agreement took effect in 1995 and specified several
liberalization measures that had an effect on the threats and opportunities of
international companies. First, members agreed to slash export subsidies by 36
percent and domestic agricultural price supports by 20 percent. These subsidy
reductions benefited major exporters in Canada, Australia, Thailand, New
Zealand, and the US. Second, the Uruguay Round set up several principles
concerning trade in services. Third, the Uruguay Round agreement strengthened
the protection of intellectual property rights which includes trademarks, patents,
copyrights, brand names, and expertise.
As a successor to GATT, the main objective of the WTO is to establish trade
policy rules that raise living standards and help expand international trade. The
WTO pursues these objectives by administering trade agreements, settling trade
disputes, acting as a forum for trade negotiations, cooperating with international
organizations, and assisting developing countries on trade policy issues through
training programs and technical assistance.
The WTO has 153 members as of July 2008. The Ministerial Conference is the
top-level decision-making body of the WTO, which meets at least once in two
years. The General Council is the highest-level decision-making body of the WTO
where member nations are represented as heads or ambassadors of delegations.
The General Council also meets as the Dispute Settlement Body and the Trade
Policy Review Body. The Goods Council, Trade-Related Aspects of Intellectual
Property Council, and Services Council report to the General Council. In addition,
several specialized working groups or committees deal with individual
agreements and other crucial areas such as the development membership
applications, environment, trade and investment, regional trade agreements, trade
and competition policy, and transparency in government procurement. Electronic
commerce is also studied by many councils and committees.

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Functions
The dominant function of the WTO is reduction of import duties. Other functions
include elimination of discrimination. The main principles designed for
eliminating discrimination are the most-favored-nation treatment and the national
treatment. The most-favored-nation (MFN) treatment means that “any advantage,
favor, or privilege granted to one country must be extended to all other member
countries.” For instance, if Canada reduced its import tariffs on German cars to
20 percent, it should cut its tariffs on imported cars from all other member nations
to 20 percent. The national treatment means that “once they have cleared customs,
foreign goods in a member country should be treated the same as domestic
goods.”
There are some exceptions to the MFN principle. First, the WTO permits
members to establish regional or bilateral custom unions or free trade areas.
Second, the WTO permits members to lower tariffs to developing countries
without lowering them to developed countries. The third exception is the escape
clauses allowed by the WTO. Escape clauses are “special allowances permitted
by the WTO to safeguard infant industries or nourish economic growth for newly
admitted developing countries.” The purpose of escape clauses is to help the
developing countries members safeguard their economies.
Another WTO function is to combat forms of protection and trade barriers. The
WTO eliminates quantitative restrictions to maintain agricultural products or to
balance foreign exchange reserve by a member government. Quantitative
restrictions on industrial products can be levied by imposing an anti-dumping
duty. Dumping is “sale of imported goods either at prices below what a company
charges in its home market or at prices below cost.” Other forms of protection
include customs valuation, subsidies, import deposit without interest, excise
duties, and countervailing duty. The non-tariff barriers were effectively combated
in the Uruguay Round. The Trade Policy Review of the WTO monitors the trade
policies of its members regularly.

Example
Insitesonindia.com dared 1st January 2022 has reported, “India has imposed
anti-dumping duty on five Chinese products, including certain aluminium
goods and some chemicals, for five years through quantitative restrictions to
guard local manufacturers from cheap imports from the neighbouring country”.
This action of India comes under one of the functions of WTO, i.e., Combat
forms of protection and trade barriers.
Source: ICFAI Research Center

Another significant function of the WTO is to provide a forum for dealing with
various emerging issues that concern the world trade system such as the
environment, regional agreements, economic development, intellectual property,

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government procurement, unfair trade practices, and special sectors such as

agriculture, financial services, telecommunications, and maritime services. From
such forum discussions, many new rules have been derived. For instance, the
Trade-Related Intellectual Property Agreement (TRIP) brings new discipline for
protecting copyrights, patents, trade secrets, and similar components of
intellectual property.
Finally, the WTO functions as a united dispute settlement system for members
through its Dispute Settlement Body which consists of representatives from
every WTO member. The DSB has the solitary authority for establishing dispute
settlement panels for cases, for adopting panel reports, for monitoring
implementation of its rulings and for authorizing suspension of rights if its rulings
are not acted upon by the members in a timely fashion.
The WTO and GATT are viewed as „club of rich nations‟ by some developing
countries. While being beneficial for the world trade in total, benefits largely on
the bargaining power a member nation or group of member nations. Developing
countries often believe that they are victims of unfair trade practices and
policies adopted by rich nations. Developing countries have asked affluent
nations to honor commitments to remove unfair treatments and open more
markets.
6.4.2 The International Monetary Fund (IMF)
The IMF and the World Bank are together referred to as the Bretton Woods
Institutions, as they were established at Bretton Woods, New Hampshire, in July
1944. The overall objectives of the IMF include expansion of international trade,
reduce disequilibrium in balance of payments of member countries, and promote
international monetary cooperation. For accomplishing these objectives, IMF
seeks to maintain orderly exchange arrangements, promote exchange stability,
avoid competitive exchange depreciation, and provide confidence to member
states. IMF was established for rendering temporary assistance to member
countries trying to defend their currencies against random, seasonal, or cyclical
fluctuations. It also assists countries having structural trade problems if they take
ample steps for correcting their problems.
The IMF is headed by Board of Governors, consisting representatives from all
member countries. The IMF requires all members to collaborate with the Fund in
promoting a stable system of exchange rates for facilitating the exchange of
goods, capital, and services, and for providing conditions essential for economic
and financial stability. Members should avoid manipulating exchange rates in
order to prevent effective balance of payments adjustments or as an effort to gain
unfair competitive advantage.
The world community has been increasingly using the IMF as a vital forum for
multilateral surveillance and coordination of monetary and fiscal policies.

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IMF has begun to develop greater flexibility for responding purposefully and
quickly to change economic conditions constantly.
The IMF created the Special Drawing Right (SDR) for carrying out tasks of
monitoring the international monetary system and supplementing foreign
exchange reserves. SDR serves as unit account for the IMF and other regional and
international organizations, and is also the base against which countries peg the
exchange rate of their currencies. SDRs are not circulated internationally.
Individual countries hold SDRs in the IMF in the form of deposits. Members settle
transactions among themselves by transferring SDRs.

Example
Business Standard dated 1 September 2021 has reported, “The International
st

Monetary Fund (IMF) has sharply increased its allocation of Special Drawing
Rights (SDR) to India, in line with the country's existing quota in the fund”.
The total SDR holdings of India now stands at SDR 13.66 billion which is
equivalent to around USD 19.41 billion as on August 23, 2021, as per the RBI
and the increased SDR will reflect in the foreign exchange reserves data. In the
given case, SDR serves as a unit account for the IMF and members settle
transactions among themselves by transferring SDRs.
Source: ICFAI Research Center

6.4.3 The World Bank Group

The World Bank refers to International Bank for Reconstruction and
Development (IBRD). It has three affiliates – the International Development
Association, the International Finance Corporation (IFC), and the Multilateral
Investment Guarantee Agency (MIGA). Together with its affiliates, World Bank
is known as the World Bank Group. The common objective of these institutions
is to help raise living standards in developing countries by channeling financial
resources to them from developed countries.
The World Bank was set up in 1945 and is owned by 160 countries. The
subscription of its member countries funds the capital of the World Bank. Its
lending operations are financed chiefly through its borrowings in the world capital
markets. A significant contribution to World Bank’s capital resources also comes
from its flow of repayments on its loans and its retained earnings. The loans
offered by the World Bank are repayable over 15 to 20 years with a grace period
of five years. Loans are geared toward developing countries that are in advanced
stages of social and economic growth. The interest rates on these loans are
calculated based on the cost of borrowing, which makes the interest rate lower
than market interest rates.
The World Bank’s charter lists basic rules governing its operations. It should lend
only for productive purposes and should stimulate economic growth in the
developing countries which are recipients of the loan. It must pay due regard to

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prospects of repayment. Each loan is made to a government or should be

guaranteed by the concerned government. The use of loans cannot be restricted to
purchases in any member country particularly.
The IDA was established in 1960. It concentrates on developing the least developed
nations. The terms of IDA credits, which are usually made to governments, are grace
period of ten years, 35- or 40- year maturities, and no interest. The IFC was set up in
1956 with the stated aim to assist the economic development of developing
countries by promoting growth in the private sector of the economies and serving
to mobilize domestic and foreign capital for this purpose. The MIGA was
established in 1988. It specializes in encouraging equity investment and other
direct investment flows to the developing countries by mitigating the non-
commercial investment barriers.

Example
In March 2020, Somalia became a member-nation of the Multilateral
Investment Guarantee Agency (MIGA). MIGA’s Executive Vice President
Hiroshi Matano stated (CNBC Africa, March 31, 2020) that it has started
looking opportunities for expanding and increasing foreign direct investments
in the fields of agri-business, energy, information and communications
technology sectors, and small and medium-sized finance sectors for Somalia.
This would help Somalia achieve higher trade flows, economic growth and
sustainable development in the long run.
Source: ICFAI Research Center

Since the late 1990s, the cooperation between the WTO, IMF, and the World
Bank has increased significantly. This includes information sharing, participation
in meetings, contacts at the staff level, and the creation of a High Level Working
Group on Coherence that manages the process and prepares an annual joint
statement on Coherence. In 1998, the WTO Secretariat collaborated with the IMF
and the World Bank staff for assisting developing countries in stimulating their
foreign trade and their participation in the multilateral trading system.

Activity 6.2
An Asian country took US$ 4 billion loan from an affiliate of theWorld Bank.
The country did not have to pay an interest to the World Ban and had to repay
the loan in a 10 year period. Identify the affiliate of the World Bank. Also
discuss other affiliates of the World Bank.
Answer:

52
6.4.4 Other International Economic Organizations
Some of the other International Economic Organizations are:
The Organization for Economic Cooperation and Development (OECD)
In December 1960, the Organization for Economic Cooperation and Development
(OECD) was established. It includes the US, Canada, Japan, Australia, New
Zealand, and Mexico. It stated mission is to aid in achieving the highest possible
growth in the economies of member countries as well as non-member states.
Its emphasis is on employment expansion, financial stability, economic
development, improvement of living standards, and extension of world trade on
a non-discriminatory and multilateral basis. The highest authority in the OECD
is the council. The OECD does not have specific provisions on liberalization of
goods, capital, and invisible transactions. After the formation of the European
Union, the aim of OECD is to coordinate the economic policies of all developed
countries.
The United Nations Conference on Trade and Development (UNCTAD)
UNCTAD is a forum that examines economic problems that plague developing
countries. It also formulates, negotiates, and implements measures for improving
the development process of developing countries. This forum is essential for
achieving the demand for “a new international economic order” that involves
more trade and capital concessions on the part of developed countries.
Developing countries hope to solve three problems through UNCTAD:
 The share of developed countries in world trade is decreasing and the terms
of trade with developed countries are deteriorating.
 Developed countries markets are not adequately open for manufacturing products of
developing countries.
 The aid given to developing countries is inadequate and they have huge foreign
debts.

6.5 Cooperation among Nations at the Regional-Level

After World War II, multilateral trade liberalization has been paralleled by an integration
process through regional agreements. From 1947 to 1994, 109 agreements have
been reported to the GATT.

Example
Business Standard dated 16th January 2022 has reported, “India's extension of
USD 400 million to Sri Lanka under the SAARC currency swap arrangement
and deferral of A.C.U. settlement of USD 515.2 million by two months, are
key assistance in the current Sri Lankan foreign currency shortage situation,
according to analysts”.
Contd….
Block 2: Global Markets and Institutions

Further Sri Lanka has urged more Indian investments in ports, infrastructure,
energy, power and manufacturing sectors, days after New Delhi announced a
USD 900 million loan to Colombo. There, the international economic
cooperation at regional level is noticed in the given case.
Source: ICFAI Research Center

India’s support to Sri Lanka in the form of economic assistance is under SAARC
framework that is the South Asian Association for the Regional Cooperation and
is at regional level as the name itself suggests.
6.5.1 Postwar Regional Integration
Postwar regional integration is characterized by three features. First, it has been
primarily centered in Western Europe. The creation of the European Economic
Community (EEC) in 1958 after signing of the treat in 1957 and the European
Free Trade Association in 1960 initiated a process that aimed to enlarge the scope
of regional integration among European countries with other countries. A
significant feature of trade policies of non-European countries is integration
through preferential trade agreements.
Second, many developing countries particularly in Asia and Latin America have
renewed their interest in regional integration since the beginning of the Uruguay
round. Regional integration can broaden the openness and internationalization of
developing economies while avoiding overdependence on world markets.
Moreover, continued economic reforms suggest that the overall policy
environment have become conducive to objectives of regional integration.
Third, the level of economic integration varies among different agreements. Most
of the regional integration agreements involve free trade areas, and the number of
customs union agreements is small. It is useful to distinguish between reciprocal
arrangements and non-reciprocal arrangements among free trade agreements. In
a reciprocal agreement, each member agrees to reduce or eliminate trade barriers.
In a non-reciprocal agreement, some developed countries may reduce barriers to
trade.
The North American Free Trade Agreement (NAFTA)
On December 17, 1992, the leaders of Canada, Mexico, and the US signed the
North American Free Trade Agreement (NAFTA), creating a tri-national market
area. NAFTA is the first free trade agreement between industrial countries and a
developing nation (Mexico). The agreement enhances the ability of North
American producers for competing globally.
NAFTA came into effect on January 1, 1994 uniting the US with its largest
(Canada) and third largest (Mexico) trading partners. On the basis of the earlier
US-Canada Free Trade Agreement, NAFTA dismantled trade barriers for
industrial goods and included agreements on agriculture, investments, services,
and intellectual property rights.

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NAFTA also includes side agreements on import surges, labor adjustments, and
environmental protection. The side agreement on import surges creates an early
warning mechanism for identifying sectors where sudden, explosive trade growth
may significantly harm the domestic industry. The side agreement on labor
adjustments came due to concerns of America workers that US jobs would be
exported to Mexico due to cheap labor, weak child labor laws, etc. The side
agreement on environmental protection ensures the rights of the US for
safeguarding the environment.
With the integration of the Mexican, Canadian, and the US markets, many
companies have changed their plans and business strategies for serving the North
American market efficiently.
6.5.2 Europe: The European Union
The postwar efforts for the formation of the European Union have been a long
process, beginning with the formation of EEC in 1957. On January 1, 1995, the
European Community (EC) was formed comprising the Netherlands, Belgium,
France, Luxembourg, Ireland, the UK, Denmark, Italy, Germany, Portugal,
Greece, Spain, Finland, Sweden, and Austria. These member states constitute the
economic level of the European economic integration. The outer tier of trade and
economic liberalization around the EC is composed of countries in eastern and
central Europe as well as the Mediterranean countries with which the EC had
included reciprocal trade agreements.
The Treaty of European Union, signed in February 1992, was enforced in
November 1993. The most basic step in strengthening political and economic ties
among member states of the EC occurred with this treaty. This treaty promotes
economic and trade expansion in a common market as well as embraces the
formation of a monetary union, common citizenship, establishment of a common
foreign and security policy, and the development of cooperation on social affairs
and justice. The treaty’s significance was marked by the adoption of European
Union (EU). The Maastricht Treaty includes several high-impacting provisions
such as:
It creates a common European currency called the European currency unit (ECU).
The ECU is a popular unit for international payment, security investment, bond
issuance, commercial loans, bank deposits, and traveler’s check.
Every citizen in an EU member state is eligible to obtain a European passport,
which allows them to move freely from one country to another within the EU.
 It includes provisions on cooperation in fields of domestic affairs and justice.
 It empowers the EU to play an active role in trans-European transport and
environmental protection.
 It increases the European Parliament’s power to enact legislation.
 It removes restrictions on capital movements between member states. It sets
a European Central Bank that is responsible for monetary policy.

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6.5.3 Asia Pacific

In November 1994, the Asia-Pacific Economic Cooperation Forum (APEC) was
founded. Its member states comprise New Zealand, Mexico, Canada, Australia,
the US, Chile, China, Japan, Hong Kong, South Korea, Papua New Guinea,
Chinese Taipei (Taiwan), Indonesia, Singapore, Malaysia, the Philippines,
Thailand, and Brunei. APEC is cross-regional spanning Asia, North, and South
America, and the Pacific.
Asia is distinctive in many ways. First, many countries have accelerated their
trade liberalization in the region at the sub-national level by authorizing special
investment areas and export processing zones within each country.
Second, many neighbors which are geographically proximate in Asia have
reached less formal trade agreements. For instance, members of South Asian
Association for Regional Cooperation (SAARC) – Bhutan, Pakistan, Sri Lanka,
Maldives, and India have concluded a trade agreement in April 1993.
Finally, numerous sub-regional economic zones have emerged. These zones are
also called transnational export processing zones, natural economic territories, or
growth triangles.

Example
The regional economic integration of ASEAN led to the signing of SIJORI pact
by three regions – an acronym for Singapore, Johor (Malaysia), and Riau
(Indonesia). A published article by Xu Xiadong in the Journal of Maritime
Studies and National Integration (2019) had stated that due to this pact
Singapore obtained the rights of drawing fresh water from Johor River in Johor.
Advanced infrastructure, financial resources and management expertise flowed
from Singapore to Riau and Johor. Singapore and Malaysia helped Riau
establish a regional centre of industry for Indonesia. Workforce mobility
improved from Johor and Riau to Singapore.
Source: ICFAI Research Center

6.5.4 ASEAN
On August 8, 1967, the Association of South East Asian Nations (ASEAN) was
established by Malaysia, the Philippines, Indonesia, Thailand, Singapore, and
Brunei. ASEAN adheres to the principles of the United Nations Charter, which
stipulated the Association to be open to participation by all stated in the Southeast
Asian region subscribing to its aims, purposes, and principles. ASEAN aims to
promote peace, stability, and economic growth in the region. In January 1992, the
AFTA agreement was signed by six member nations including Brunei, Indonesia,
Malaysia, Philippines, Singapore and Thailand. Vietnam joined in 1995 followed
by Laos and Myanmar in 1997 and by Cambodia in 1999. The AFTA is a trade
bloc agreement that aimed to support local manufacturing in all the ASEAN
countries. The primary goal of AFTA is to increase ASEAN‟s competitive edge
as a production base in the world market b elimination tariff and non-tariff barriers

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within ASEAN countries. In order to become a free trade zone, ASEAN countries
have cut tariffs on several products such as chemicals, ceramics, cement,
pharmaceuticals, etc. Another major goal of AFTA is to attract foreign direct
investment to ASEAN. As of 2011, the member states of ASEAN included
Brunei, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines,
Singapore, Thailand, and Vietnam. The member countries of ASEAN are diverse
in terms of geographical, economic, political, and cultural backgrounds.
6.5.5 SAARC
Founded in December 1985, South Asian Association for Regional Cooperation
(SAARC) is an association of South Asian nations. Its members include
Bangladesh, Bhutan, India, Pakistan, Maldives, Sri Lanka, Nepal, and
Afghanistan are dedicated to social, economic, technological, and cultural
development. The areas of cooperation include Agriculture; education, culture,
and sports; environment and meteorology; tourism; transport; communication;
rural development; health, population, and child welfare; and science and
technology.
6.5.6 Latin America
In 1960, the Latin American Free Trade Association (LAFTA) was formed in
Latin America by Argentina, Brazil, Bolivia, Colombia, Chile, Ecuador, Mexico,
Peru, Paraguay, Uruguay, and Venezuela. In the same year, the Central American
Common Market (CACM) was formed by Costa Rica, El Salvador, Guatemala,
Honduras, and Nicaragua. Both the agreements failed to achieve their objectives
of due to different economic policies and economic conditions.
In 1973, the Caribbean Community and Common Market (CARICOM) were
started by the Caribbean region. The objectives of this treaty is to achieve
economies of scale in the regional production of transportation, services, health,
education, and to pool financial resources for investment in a regional
development bank. This treaty also targets coordination of development planning
and economic policies.
In 1980, LAFTA was superseded by Montevideo Treaty, which set up the Latin
America Integration Association (LAIA) with the stated goal to increase bilateral
trade among member countries.

Example
The economic and business magazine Atalayar dated 5th November 2021 has
published an article on the increased trade between Argentina and Brazil.
“Argentina has achieved its highest level of exports to Brazil in the month of
October 2021 worth US$1.218 billion”. The article also mentions the good
prospects of increased trade between the member countries of the economic
regional forum comprising Argentina, Brazil, Bolivia, Colombia, Chile,
Ecuador, Mexico, Peru, Paraguay, Uruguay, and Venezuela.
Contd….

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Here, LAIA is the trade agreement that represents the trade between Brazil and
Argentina in the given case.
Latin America Integration Association (LAIA) was formed to increase bilateral
trade among member countries of Latin America comprising Argentina, Brazil,
Bolivia, Colombia, Chile, Ecuador, Mexico, Peru, Paraguay, Uruguay, and
Venezuela. The trade between Argentina and Brazil falls under LAIA.
Source: ICFAI Research Center

In 1991, the Southern Common Market Treaty (MERCO-SUR) was formed by

Argentina, Brazil, Paraguay, and Uruguay, which formed a common market for
free circulation of labor, capital, goods, and services. The member countries also
aimed to coordinate macroeconomic policy and harmonize legislation for
strengthening the integration process. Since January 1, 1995, members of the
MERCOSUR have used common external tariff rates and common tariff
structures.
Other members of the LAFTA, including Colombia, Peru, Bolivia, Ecuador, and
Venezuela formed the Andean Free Trade Area in 1992 with a common external
tariff. On January 1, 1993, the Central American Common Market (CACM)
established a customs union and reactivated its objectives.
6.5.7 Africa and the Middle East
In 1975, the Economic Community of West African States (ECOWAS) was
established with members comprising Burkina Faso, Benin, Mali, Niger,
Mauritania, Cote d‟lvoire, Senegal, Liberia, Guinea, Cape Verde, Sierra Leone,
Ghana, Gambia, Nigeria, Togo, and Guinea-Bissau. In 1981, ECOWAS
eliminated duties on unprocessed agricultural products and handicrafts. In 1990,
it implemented free trade for all unprocessed products. Other activities include
steps to avoid the use of hard currencies in intra-member trade through a regional
payments-clearing system, progressive liberalization of industrial products, and
cooperation on industrial and agricultural investment projects.

Example
The nationonline.net dated 22nd December 2021 has reported that “two western
African states Nigeria, Ghana have decided to get the trade dispute settlement
amongst themselves under the regional forum of western African countries for
the implementation of trade and other economic related activities and both have
signed joint statement” in this regard. This was necessitated in order to engage
and effectively find a lasting solution to the recurring dispute between Nigerian
traders and their Ghanaian counterparts. In the given case, ECOWAS is the
regional forum under which western African countries can settle their disputes
and implement free trade.
Source: ICFAI Research Center

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In 1966, in former French Africa, the Central African Economic and Customs
Union (UDEAC) was established comprising Gabon, Chad, Congo, the
Equatorial Guinea, the Central African Republic, and Cameroon. The EDEAC
offers a framework for free capital movement throughout the area,
harmonization of fiscal incentives, and coordination of industrial development.
In 1990, a common external tariff was introduced by four member countries –
Cameroon, Gabon, the Central African Republic, and Congo.
In 1967, the East African Economic Community (EAEC) was formed in former
British East Africa by Tanzania, Uganda, and Kenya. In 1979, the EAEC was
dissolved and three members joined with other states (Angola, Burundi, Comoros,
Djibouti, Ethiopia, Lesotho, Malawi, Mauritius, Mozambique, Namibia, Rwanda,
Somalia, Sudan, Swaziland, Zambia, and Zimbabwe) for establishing the
Preferential Trade Area for eastern and south African states in 1981. Its goal
includes establishing a common market and promoting trade and economic
cooperation among its members.
In 1981, Kuwait, Oman, Bahrain, Qatar, Saudi Arabia, and the UAE established
the Gulf Cooperation Council (GCC) in the Middle East. A free trade area that
covered agricultural and industrial products was set. In 1989, the Arab Maghreb
Union was set up by Algeria, Morocco, Mauritania, and Tunisia, for laying the
foundation for a Maghreb Economic Area.

6.6 Cooperation among Nations at the Commodity-Level

The emergence of several international commodity agreements is a natural development
in the international economic relations. Countries may also cooperate for
controlling the pricing, sale, and production of goods that are traded
internationally. A commodity cartel is “a group of producing countries that wish
to protect themselves from the wild fluctuations that often occur in the prices of
certain commodities traded internationally (e.g. coffee, rubber, cocoa, or crude
oil).” Cartel members may seek stable and higher prices for their goods. A
commodity cartel can increase the prices of their goods in international markets
by limiting overall output and assigning production quotas to individual
countries. The two important commodity cartels that influence the world
economy are OPEC and the Multifiber Arrangement.
6.6.1 Organization of Petroleum Exporting Countries (OPEC)
The Organization of Petroleum Exporting Countries (OPEC) is the most notable
and critical commodity. It is not a commercial entity, but an intergovernmental
organization. It has 13 members, including Iraq, Iran, Kuwait, Saudi Arabia,
Algeria, Venezuela, Ecuador, Indonesia, Libya, Gabon, Nigeria, Qatar, and the
United Arab Emirates. OPEC is the strongest collective force that impacts oil
prices in the international oil market. OPEC controls the price in world markets
by assigning its members production quotas that limit the overall amount of crude
oil that would be supplied internationally.

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OPEC became a catalyst for action by developing countries to make sure export
earnings that are remunerative from their topical products and raw materials. For
instance, The Intergovernmental Council of Copper Exporting Countries and The
International Bauxite Association were formed in the 1970s by major developing
countries that produced these commodities.
6.6.2 The Multifiber Arrangement (MFA)
The Multifiber Arrangement (MFA) originally signed in 1972 is an agreement
between exporting and importing countries for controlling exports of apparel and
textiles from developing countries to developed countries. The MFA took
advantage of a GATT rule exemption that allowed individual importing countries
to establish quota and other restrictions on apparel and textile exports on a
country-by-country basis. Nearly two-thirds of the apparel and textile products
traded internationally were covered by the MFA.
The MFA had been renewed several times due to the lack of a better solution
between developing and developed over the trade involving apparel and textile
trade. For instance, the US and China negotiated yearly over the quota of Chinese
exported garments and textiles. The process was lengthy due to conflicts over
issues on which both the parties do not compromise. The MFA governed the
world trade in textiles and garments till 2004. In 2004, at the GATT Uruguay
round it was decided that the textile trade would be brought under the WTO.
Hence the MFA expired on January 1, 2005. Thus, the MFA ended on Jan. 1, 1995,
and was replaced by the Agreement on Textiles and Clothing under the World
Trade Organization (WTO)
6.6.3 Other international Commodity Arrangements
Other multilateral commodity arrangements include The International Sugar
Agreement, The International Tin Agreement, The International Cocoa
Agreement, The Wheat Trade Convention, the International Coffee Agreement,
and the International National Rubber Agreement.

6.7 Strategic Responses of Multinational Enterprises

International economic integration has a profound effect on the operations of
multinational enterprises. The activities of an MNE are triggered by economic
integration, which then increases foreign direct investment in the integrated
region. In response to regional economic integration, some strategies can be
identified. The defensive export substituting investment is a strategy by which
MNEs protect their existing market share gained through exports by switching to
direct production inside the region. For instance, Dow Chemicals and Du Pont
had increased investments in their export-oriented operations in Canada in
reaction to NAFTA.
Another strategy adopted by MNEs is the offensive export substituting strategy
in which MNEs prefer to ensure market penetration by making direct investments

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 Unit 6; International Economic Integration and Institutions

in the region before the region is officially integrated. This strategy helps an MNE
gain an early position in the market.
The third strategy is the rationalized foreign direct investment strategy in which
MNEs increase their investment and heighten resource commitment to the
integrated region to gain greater economic efficiency through market expansion
and scale economies.
Finally, the reorganization investment is a strategy by which MNEs realign their
value-added activities and organizational structures in order to reflect a regional
market. Firms realign investment capital among trading bloc members once the
protective barriers are removed. Under this strategy, MNEs increase their cross-
border investment activities within the region.
In response to economic integration, MNEs, including those from developing
economies such as Brazil, South Korea, Singapore, and Taiwan have been
employing cross-border strategic alliances actively. These alliances allow then
to enter new markets more rapidly than mergers or acquisitions.

Check Your Progress - 1

1. concerns removal of trade barriers or impediments between at

least two participating nations and establishing and coordinating between
them.
a. Economic integration
b. Dumping
c. Anti-dumping
d. None of the above
2. Free trade area involves country combination, where the member nations
remove trade barriers among themselves while retaining their freedom related
to policy making vis-à-vis non-member countries.
a. Free trade area
b. Political union
c. Customs union
d. Common market
3. Customs union is identical to free trade area except that member nations must
pursue and conduct common external commercial relations like common
tariff policies on imports from non-member nations.
a. Common market
b. Economic union
c. World Trade Organization
d. Customs union

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Block 2: Global Markets and Institutions

4. Common market is a particular customs union that permits free trade of

products and services only but with free mobility of production factors across
national member borders.
a. Political union
b. ASEAN
c. Common market
d. Multifiber Arrangement
5. Economic union is a particular common market that unifies fiscal and
monetary policies.
a. European union
b. Political union
c. Economic union
d. None of the above
6. Political union involves establishing a common parliament and other political
institutions.
a. Political union
b. Free trade area
c. NAFTA
d. LAFTA
7. came as a successor to the General Agreement on Tariffs
and Trade (GATT).
a. World Bank
b. World trade organization
c. SAARC
d. IMF
8. The means that any advantage, favor, or privilege granted to
one country must be extended to all other member countries.
a. Regional treatment
b. National treatment
c. Most-favored nation treatment
d. International treatment
9. The means that once they have cleared customs, foreign goods
in a member country should be treated the same as domestic goods.
a. National treatment
b. Most-favored nation treatment
c. Regional treatment
d. None of the above

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 Unit 6; International Economic Integration and Institutions

10. _________are special allowances permitted by the WTO to safeguard infant

industries or nourish economic growth for newly admitted developing
countries.
a. Quotas
b. Cartels
c. Escape clauses
d. Subsidies
11. ___________is sale of imported goods either at prices below what a company
charges in its home market or at prices below cost.
a. Anti-dumping
b. Depreciation
c. Dumping
d. Revaluation
12. The IMF and the are together referred to as the Bretton Woods
Institutions.
a. World Trade Organization
b. World Bank
c. ASEAN
d. NAFTA
13. The refers to International Bank for Reconstruction and Development
(IBRD).
a. International Monetary Fund
b. Multifiber Agreement
c. European Union
d. World Bank
14. ______________is the first free trade agreement between industrial countries
and a developing nation (Mexico).
a. LAFTA
b. NAFTA
c. MERCOSUR
d. European Union
15. A is a group of producing countries that wish to protect
themselves from the wild fluctuations that often occur in the prices of certain
commodities traded internationally (e.g. coffee, rubber, cocoa, or crude oil).
a. Customs union
b. Political union
c. Free trade area
d. Commodity cartel

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Block 2: Global Markets and Institutions

16. The is the strongest collective force that impacts oil prices in
the international oil market.
a. ASEAN
b. MFA
c. OPEC
d. SAARC
17. The originally signed in 1972 is an agreement between
exporting and importing countries for controlling exports of apparel and
textiles from developing countries to developed countries.
a. OPEC
b. Multifiber Arrangement
c. NAFTA
d. WTO

6.8 Summary
 Economic integration concerns removal of trade barriers or impediments
between at least two participating nations and establishing and coordinating
between them.
 Free trade area involves country combination, where the member nations
remove trade barriers among themselves while retaining their freedom related
to policy making vis-à-vis non-member countries.
 Customs union is identical to free trade area except that member nations must
pursue and conduct common external commercial relations like common
tariff policies on imports from non-member nations.
 Common market is a particular customs union that permits free trade of
products and services only but with free mobility of production factors across
national member borders.
 Economic union is a particular common market that unifies fiscal and
monetary policies.
 Political union involves establishing a common parliament and other political
institutions.
 The World Trade Organization came into being on January 1, 1995 as a
multilateral trade organization that aimed at international liberalization of
trade.
 The overall objectives of the International Monetary Fund include expansion
of international trade, reduce disequilibrium in balance of payments of
member countries, and promote international monetary cooperation.

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 Unit 6; International Economic Integration and Institutions

 In December 1960, the Organization for Economic Cooperation and

Development (OECD) was established. It stated mission is to aid in achieving
the highest possible growth in the economies of member countries as well as
non-member states.
 UNCTAD is a forum that examines economic problems that plague
developing countries.
 NAFTA is the first free trade agreement between industrial countries and a
developing nation (Mexico). The agreement enhances the ability of North
American producers for competing globally.
 The Treaty of European Union, signed in February 1992, promotes economic
and trade expansion in a common market as well as embraces the formation
of a monetary union, common citizenship, establishment of a common foreign
and security policy, and the development of cooperation on social affairs and
justice.
 In November 1994, the Asia-Pacific Economic Cooperation Forum (APEC)
was founded.
 The Association of South East Asian Nations aims to promote peace, stability,
and economic growth in the region.
 In 1960, the Latin American Free Trade Association (LAFTA) was formed in
Latin America by Argentina, Brazil, Bolivia, Colombia, Chile, Ecuador,
Mexico, Peru, Paraguay, Uruguay, and Venezuela.
 The Economic Community of West African States (ECOWAS) eliminated
duties on unprocessed agricultural products and handicrafts.
 In 1981, Kuwait, Oman, Bahrain, Qatar, Saudi Arabia, and the UAE
established the Gulf Cooperation Council (GCC) in the Middle East. A free
trade area that covered agricultural and industrial products was set.
 The Organization of Petroleum Exporting Countries (OPEC) is the strongest
collective force that impacts oil prices in the international oil market.
 The Multifiber Arrangement (MFA) originally signed in 1972 is an agreement
between exporting and importing countries for controlling exports of apparel
and textiles from developing countries to developed countries.
 In response to regional economic integration, some strategies can be
identified. defensive export substituting investment offensive export
substituting strategy rationalized foreign direct investment strategy
reorganization investment

6.9 Glossary
Commodity cartel: A commodity cartel is a group of producing countries that
wish to protect themselves from the wild fluctuations that often occur in the prices
of certain commodities traded internationally (e.g. coffee, rubber, cocoa, or crude
oil).

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Block 2: Global Markets and Institutions

Dumping: Dumping is sale of imported goods either at prices below what a

company charges in its home market or at prices below cost.
Escape clauses: Escape clauses are special allowances permitted by the WTO to
safeguard infant industries or nourish economic growth for newly admitted
developing countries.
Most-favored-nation (MFN) treatment: The most-favored-nation (MFN)
treatment means that any advantage, favor, or privilege granted to one country
must be extended to all other member countries.
National treatment: The national treatment means that once they have cleared
customs, foreign goods in a member country should be treated the same as
domestic goods.

6.10 Self-Assessment Test

1. Define economic integration. Explain different forms of economic
integration.
2. The three fundamental institutions affecting cooperation among nations at the
global level are the World Trade Organization, the International Monetary
Fund, and the World Bank. Explain the background and functions of these
institutions in brief.
3. Explain different regional agreements followed worldwide that had resulted
in elimination of various trade barriers.
4. Define a commodity cartel. Explain briefly the two important commodity
cartels that influence the world economy.
5. Discuss the strategic responses of multinational enterprises to regional
economic integration.

6.11 Suggested Readings/Reference Material

1. Charles W L Hill and G Thomas M Hult (2021). International Business –
Competing in the Global Marketplace. 12th edition, McGraw Hill India.
2. Oded Shenkar, Yadong Luo, Tailan Chi (2021). International Business, 4th
edition, Routledge
3. Alan C Shapiro (2019). Multinational Financial Management, 11th Edition,
Wiley
4. Prakash G Apte (2017). International Financial Management, 8th edition,
McGraw-Hill India
5. H.G.Mannu (2018). International Economics. Vikas Publishing House
6. Francis Cheunilam (2020). International Business – Text and Cases. 6th
edition. Prentice Hall India Learning Private Limited
7. John Wild and Kenneth Wild (2019). International Business – The Challenges
of Globalization. Pearson Education

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 Unit 6; International Economic Integration and Institutions

Additional References:
1. Serenity Gibbons. How to expand your business internationally without
compromising your core model. Forbes (2020).
https://www.forbes.com/sites/serenitygibbons/2020/03/24/how-to-expand-a-
business-internationally-without-compromising-your-core-
model/?sh=66335a6f741d
2. IFRS Foundation. Use of IFRS standards around the world. 2018.
https://cdn.ifrs.org/-/media/feature/around-the-world/adoption/use-of-ifrs-
around-the-world-overview-sept-2018.pdf
3. Brett Steenbarger. Why diversity matters in the world of Finance. 2020.
https://www.forbes.com/sites/brettsteenbarger/2020/06/15/why-diversity-
matters-in-the-world-of-finance/?sh=36dba0637913
4. IFC. Social and Green Bonds.
https://www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corpor
ate_site/about+ifc_new/investor+relations/ir-products/socialbonds
5. Business Insider. Global ecommerce market report: ecommerce sales trends
and growth statistics for 2021. https://www.businessinsider.com/global-
ecommerce-2020-report?IR=T

6.12 Answers to Check Your Progress Questions

1. (a) Economic integration
Economic integration concerns removal of trade barriers or impediments
between at least two participating nations and establishing and
coordinating between them.
2. (a) Free trade area
Free trade area involves country combination, where the member nations
remove trade barriers among themselves while retaining their freedom
related to policy making vis-à-vis non-member countries.
3. (d) Customs union
Customs union is identical to free trade area except that member nations
must pursue and conduct common external commercial relations like
common tariff policies on imports from non-member nations.
4. (c) Common market
Common market is a particular customs union that permits free trade of
products and services only but with free mobility of production factors
across national member borders.
5. (c) Economic union
Economic union is a particular common market that unifies fiscal and
monetary policies.

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Block 2: Global Markets and Institutions

6. (a) Political union

Political union involves establishing a common parliament and other
political institutions.
7. (b) WTO
WTO came as a successor to the General Agreement on Tariffs and
Trade (GATT).
8. (c) Most-favored nation treatment
The most-favored-nation (MFN) treatment means that “any advantage,
favor, or privilege granted to one country must be extended to all other
member countries.
9. (a) National treatment
The national treatment means that “once they have cleared customs,
foreign goods in a member country should be treated the same as
domestic goods.
10. (c) Escape clauses
Escape clauses are special allowances permitted by the WTO to
safeguard infant industries or nourish economic growth for newly
admitted developing countries.
11. (c) Dumping
Dumping is “sale of imported goods either at prices below what a
company charges in its home market or at prices below cost.
12. (b) World Bank

The IMF and the World Bank are together referred to as the Bretton
Woods Institutions.
13. (d) World Bank

The World Bank refers to International Bank for Reconstruction and

Development (IBRD).
14. (b) NAFTA

NAFTA is the first free trade agreement between industrial countries and
a developing nation (Mexico).
15. (d) Commodity cartel

A commodity cartel is “a group of producing countries that wish to

protect themselves from the wild fluctuations that often occur in the
prices of certain commodities traded internationally (e.g. coffee, rubber,
cocoa, or crude oil).

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 Unit 6; International Economic Integration and Institutions

16. (c) OPEC

The Organization of Petroleum Exporting Countries (OPEC) is the
strongest collective force that impacts oil prices in the international oil
market.
17. (b) Multifiber Arrangement

The Multifiber Arrangement (MFA) originally signed in 1972 is an

agreement between exporting and importing countries for controlling
exports of apparel and

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 International Business
Course Structure

Block 1: An Overview of International Business

Unit 1 International Business and Globalization
Unit 2 International Trade Theories and Application
Unit 3 Country Differences
Block 2: Global Markets and Institutions
Unit 4 International Monetary System
Unit 5 Foreign Exchange Markets
Unit 6 International Economic Integration and Institutions
Block 3: International Business Strategy and Structure
Unit 7 The Strategy of International Business
Unit 8 The Organization of International Business
Unit 9 Entry Strategies and Strategic Alliances
Block 4: Functional Areas in International Business
Unit 10 Global Research and Development
Unit 11 Global Human Resource Management
Unit 12 Global Marketing and Supply Chain
Unit 13 Accounting in the International Business
Unit 14 Financial Management in International Business
Block 5: Emerging Issues in International Business
Unit 15 Implementation and Control in International Business
Unit 16 Global Internet and e-Commerce
Unit 17 Ethics in International Business