Recent Trends In International Business

INTERNATIONAL BUSINESS

Objectives of Session One • International business and drivers, need for international business • What is an MNC, Pros and cons for an MNC in a country especially in a developing country like India • Country competitiveness and whether India is competitive, discussions on India’s infrastructure and other environment • Opportunity scanning for international business in the manufacturing and service sectors of India • Modes of entry into a country with examples of how and why different MNCs have entered into India • FDI and its economic, political and operational impacts on a country and on India • FIIs and their impact on the Indian industries and stock exchange  

WHEN IB • when businesses cross borders: (subsidiaries) • production and operations, and marketing is done internationally, • human resources belong to more than one country • international investment is involved, • the business is international • of products, Mcdonald’s • of markets, Harry Ramsden

DRIVERS • Worldwide trend of the economies of the world becoming borderless and interlinked. • National economies merging into an interdependent global economic system. • Declining trade and investment barriers • Perceived distances are shrinking due to advances in transportation and telecommunications. • Material culture is beginning to look similar. • Technological change: Microprocessors and Telecommunications • The Internet and World Wide Web • Changing demographics

The Shrinking Globe-The death of distance 1500-1840

Best average speed of horse-drawn coaches and sailing ships, 10mph.

1850-1930

Steam locomotives average 65mph. Steamships average 36mph.

1950s

1960s Jet passenger aircraft 500-700mph.

The Changing World Order • • • • • • • • •

Apartheid Berlin wall Disintegrated USSR The fall of Communism in Eastern Europe and the former Soviet Union. Czechoslovakia has divided itself into two states. Yugoslavia has divided into 5 (often warring) successor states. Pro-democracy movement (suppressed) in China. Latin America has seen both democracy and free market reforms. NEP of India

WHY AN MNC? • • • • • • • • •

brings in additional capital brings in additional revenue via taxation technology transfer to local firms managerial knowhow skill development and training employment creation infrastructure development industry linkage effects export enhancement

WHY ARE MNCS CRITICISED ? • • • • • •

SOVEREIGNTY (NIGERIA, EAST INDIA COMPANY) ECONOMIC OBJECTIVES(KFC,ENRON) JUNK TECHNOLOGY CULTURAL DEGRADATION WAGE DIFFERENCES POLLUTION(NAFTA,UNION CARBIDE)

MNCS HAVE THEIR USES • • • • • •

JOBS MANAGEMENT PRACTICES TECHNOLOGY TRANSFER QUALITY OF LIFE UNIVERSALISATION OF CULTURE, STANDARDISATION, NEGOTIATION SKILLS.

Country Competitiveness IS INDIA COMPETITIVE?

Country Competitiveness: a country’s ability to generate wealth in comparison to other countries Factor Endowments: – natural resources – climate – location – demographics

The Country Context • National contexts differ in a number of respects: – Economic system – Political system – Legal system – Cultural system • Their unique interactions make up the country’s political economy • This in turn influences the competitive environment for MNCs

Advanced Factor Endowments: • communications skilled labor research technology • Are the result of investment by people, companies, government. • Lead to competitive advantage.

OTHER COUNTRY FACTORS • Purchasing Power Parity: The number of units of a country’s currency required to buy the same amt of goods/services in the domestic market as one $ would buy in US • India is the second largest among developing nations based on the purchasing power parity indicator. • Institutions supporting science, education and innovation • Infrastructure development (power and energy, roads and ports, communications) • Openness or closedness of economy (international orientation)

IS INDIA COMPETITIVE? OUR STRENGTHS Political System: Democracy – Government by people exercised directly or through elected representatives.

MIXED ECONOMY: • Consumers influence production by exercising their power of choice • Legal and institutional frameworks to safeguard economic choice

Global services location index by AT Kearney. •

India is the best place to start a business • Has displaced the US to become the second-most favoured destination for foreign direct investment after China.  Been named as the top reformer in South Asia in the annual Doing Business Report issued by the International Finance Corporation (IFC).  In 2006, an international consultancy firm rated India second, ahead of the US, in the FDI Confidence Index, while UNCTAD put India as the third most attractive destination in the world for FDI.

• Fifth largest economy in the world, ranking above France, Italy, the United Kingdom, and Russia • Has the third largest GDP in Asia. • Massive market • Exceptional economic prospects • Little external susceptibilities • Steady price levels • A fair amount of candidness in business dealings • A sizeable English-speaking population.

• Host-country policies that suit foreign investors, such as promotion of private ownership and financial market regulation. • India is the software super power, • Houses a large number of IT Parks, Business Centres and SEZs in Bangalore, Gurgaon, Noida, Hyderabad, Chennai, Chandigarh, Kolkata, Mumbai and Pune. • India is the world's most preferred manufacturing “hub”.

Other unique Strengths Indian Youth • Some 65 percent of India is below 35 and 50 per cent below 25. In 2025, the median age for India will be 31, against 39 for the US and China and 44 for Russia and the UK. • The share of those aged 65 and above in the total population is less than 5 percent in India, compared to 19 percent in Japan, 18 percent in Germany, 12 percent in the US and close to 8 percent in China.

The power of Knowledge • Indians have become the "brains of the world", backed by the excellent English and communication skills. • IITs, IIMs and other institutions • Information Technology (IT) services, Business Process Outsourcing(BPO) and now Knowledge Process Outsourcing(KPO) • Professionally educated and experienced manpower.

Enterprise • IIM students are turning down Rs 1 crore plus salary to start ventures of their own. • The fear of failure has vanished. • India's roaring entrepreneurial culture has also outbid Chinese in serious business overseas. • A recent study by the Duke University’s School of Engineering and University of California's Berkley School of Information reveals that between 1996 and 2006,Indian immigrants founded more engineering and technology companies in the us than Chinese and Taiwanese and British immigrants put together. • In fact, one in every four-technology companies set up by immigrants had an Indian founder.

Indian Software Industry is estimated to be worth USD 1.2 billion. • More companies are receiving the ISO 9000 certification • Toyota Chairman Okuda Hiroshi praised the quality of products made in India, which he said was better than even Japanese companies.

INDIA’S FOREIGN TRADE: AUGUST, 2008 A. EXPORTS • Exports during August, 2008 were valued at US $ 16005 million which was 26.9 per cent higher than the level of US $ 12614 million during August, 2007. • In rupee terms, exports touched Rs. 68721 crore, which was 33.5 per cent higher than the value of exports during August, 2007. • Cumulative value of exports for the period April- August, 2008 was US$ 81225 million (Rs. 342477 crore) as against US$ 60101 million (Rs. 246180 crore) • registering a growth of 35.1 per cent in Dollar terms and 39.1 per cent in Rupee terms over the same period last year.

C. CRUDE OIL AND NON-OIL IMPORTS: Oil imports during August, 2008 were valued at US $ 10962 million which was 76.7 per cent higher than oil imports valued at US $ 6202 million in the corresponding period last year. Oil imports during April- August, 2008 were valued at US$ 45967 million which was 59.6 per cent higher than the oil imports of US$ 28798 million in the corresponding period last year.

B. IMPORTS Imports during August, 2008 were valued at US $ 29946 million representing an increase of 51.2 per cent over the level of imports valued at US $ 19805 million in August, 2007. In Rupee terms, imports increased by 59 per cent. Cumulative value of imports for the period April- August, 2008 was US$ 130364 million (Rs. 550123 crore) as against US$ 94664 million (Rs. 387791 crore) registering a growth of 37.7 per cent in Dollar terms and 41.9 per cent in Rupee terms over the same period last year.

• Non-oil imports during August, 2008 were estimated at US $ 18985 million which was 39.6 per cent higher than non-oil imports of US$ 13603 million in August, 2007. • Non-oil imports during April- August, 2008 were valued at US$ 84397 million which was 28.2 per cent higher than the level of such imports valued at US$ 65846 million in April- August, 2007.

D. TRADE BALANCE • The trade deficit for April- August, 2008 was estimated at US $ 49139 million which was higher than the deficit at US $ 34543 million during April- August, 2007.

• Steel tycoon Lakshmi Niwas Mittal has pledged an investment of about US$ 20 billion for building two 12-million-tonne steel plants in the states of Jharkhand and Orissa. • Vodafone, the world's second-biggest mobile firm, plans to spend US$ 2 billion a year on capital expenditure in India. • Eyeing the projected 15 per cent growth in the luxury car market segment, DailmerChrysler India Pvt Ltd, makers of Mercedes-Benz cars, has decided to set up a new plant in Pune. • Israeli mall developer Plaza Center NV will invest US$ 1.22 billion over the next five-seven years to set up 50 malls in India. • Nokia plans to invest US$ 100 million in India in the next three years to ramp up its capacity in Chennai. • US-based aircraft engine manufacturer, Pratt and Whitney, plans to invest about US$ 30 million in the infotech and spare parts manufacturing sector.

INDIA ABROAD-The year 2006 marks the point when, 60 years after independence from colonial rule, Indians are investing more abroad than the country is receiving as foreign direct investment (FDI). • The Mukesh Ambani-owned Reliance Industries, India’s second largest private firm, aims to be among the top 10 in the list. • With Novelis, Kumar Birla's Hindalco Industries will definitely be entering the list, three years ahead of its target year. • Indian firms, like Videocon, Moser Baer and Bharat Forge have emerged as global leaders in their respective sectors. • 'The Apollo Group of Hospitals may strike cross border deals through strategic partners with some of the local hospital chains overseas while pursuing mergers and acquisitions in the US and Europe’. • Nicholas Piramal India Ltd plans to invest $50 million over a three-year period in its plants in the UK and India

• In the energy sector, India's Suzlon Energy Limited, the world's fifth largest wind turbine manufacturer, bid $1.3 billion for Germany's RE power. A BCG report said that the axis of corporate power was shifting towards the BRIC (Brazil, Russia, India and China) countries. It identified 100 new global challengers from these nations, including 21 Indian firms, including Bharat Forge, Hindalco, Videocon and Tata Steel. • A McKinsey study (2006) found the dynamics in emerging markets like India "actually provide an invaluable springboard" for their companies to go global. • A 2006 study by Mape, an investment bank, concluded "the Indian Multinational Company (MNC) has finally come of age" and "Indian buyers have become a force to reckon with in many industries such as pharma, auto components and oil and gas".

• Manufacturing and construction, which grew at 12 per cent in 200607, decelerated by about 2.5 percentage points in 2007-08. The slower growth of consumer durables was the most important factor in the slowdown of manufacturing. • There was a sharp acceleration in the growth of manufacturing from 3.3 per cent during the Ninth Five Year Plan to 8.6 per cent during the Tenth Five Year Plan. The average growth of manufacturing during the five years ending 2007-08 is expected to be about 9.1 per cent. • The contribution of manufacturing to overall growth increased from about 9.6 per cent during the Ninth Five Year Plan to about 17.7 per cent during the Tenth Five Year Plan.

• Among the subsectors of services, “transport and communication” has been the fastest growing with growth averaging 15.3 per cent per annum during the Tenth Five Year Plan period followed by “construction”. The impressive progress in the telecommunication sector and higher growth in rail, road and port traffic played an important role in the growth of this sector. • The two other sectors whose contribution to growth has increased over the two plans are construction and communications. The contribution of the construction sector increased to 10.8 per cent during the Tenth Five Year Plan from 7.5 per cent during the Ninth Five Year Plan, while that of telecom increased to 11.4 per cent from 6 per cent over the two plans.

• The growth of “financial services” comprising banking, insurance and business services, after declining to 5.6 per cent in 2003-04 bounced back to 8.7 per cent in 2004- 05, 11.4 per cent in 2005-06 and 13.9 per cent in 2006-07. Manufacturing, construction and communication were the leading sectors in the acceleration of growth during the Tenth Five Year Plan

Attention needing areas • Education • Infrastructure • Health: the Indian health system is ranked 118 among 191 WHO member countries on overall health performance • Judicial system • Etiquette

India Inc’s bottlenecks • Irrational policies (tax structure and trade barriers). • Low investment in infrastructure - physical and information technology. • Slow reforms (political reforms to improve stability, privatization and deregulation, labour reforms).

Starting a business • It took 35 days to register a company in Mumbai in 2006 as compared to 71 days in 2005 and 89 days in January 2004. • The OECD average is 17 days. Within India the shortest time to start a business is 35 days in Mumbai. It takes the longest in New Delhi and Bhubaneshwar (52 days).

The number of procedures to start a business

The number of procedures to start a business in India is 11 as compared with the OECD average of 7 procedures and the South Asia average of 8.

Official costs of starting a business In India, a minimum capital requirement is not required. Yet, the official costs to start a business are high, at 74% of income per capita. This has risen from 62% over a year, following increases in VAT registration fees. Costs in India are far above global benchmarks which are as low as 0% of income per capita in Denmark and 9% of income per capita in China, whereas the South Asia average is 47% and the East Asia average is 43%.

Dealing with licenses   Obtaining the necessary licenses to construct a warehouse is 606% of income per capita. It requires 20 procedures and 270 days. The South Asia average is 16 procedures and 226 days, costing 375% of income per capita. It ranks 155th in the world on the ease of licensing.

Registering property Regarding the ease of registering property, India ranks 110th in the world. The process itself takes 6 procedures and 62 days. When contrasted, it takes only 1 day in Norway, 32 days in China and 47 days in Brazil.

Costs of registering property Entrepreneurs in India must shell out 8% of the property value to register a transfer of ownership. On an average, in South Asia property registration costs 5% of the property value. It is only 3% in China, and there is no such cost involved in Saudi Arabia.

Getting credit

• India gets the 65th rank on the simplicity of getting credit for business purposes. • India scores 5 out of 10 on the legal rights index, which measures the degree to which collateral and bankruptcy laws facilitate lending.

Paying taxes • India ranks 158th in ranking on the ease of paying taxes. and the time spent on complying with tax requirements is is 264 hours per year. The tax regime requires 59 separate payments annually. • Over 81.1 percent of the commercial profits is payable in tax. In China, businesses spend 872 hours per year and in Brazil 2,600 hours per year, the tax rate of 81 percent is higher than that of Brazil at 71.7% and China at 77.1%.

Trading across borders India ranks 139th on the ease of trading across borders, whereas Afghanistan is ranked 152 and Bhutan is ranked at 150. Exporting goods takes 27 days, over the previous year’s time of 36 days. The East Asia average is 24 days and in China it takes 18 days to export goods. Importing in India takes 41 days to complete import procedures as contrasted with East Asia, where importing requires 26 days. It takes 22 days to import in China.

Documents in trading Indian exporters submit 10 documents, compared with the regional average of 8 documents and the East Asia average of 7 documents. For importing it takes 15 documents in India contrasted with 9 documents in China.

Enforcing contracts Commercial disputes before courts in India are among the most lengthy, costly and complex in South Asia and globally, resulting in a rank of 173 on the ease of enforcing contracts. It takes 1,420 days to enforce a contract in India, compared with 969 days on an average in South Asia, 351 days on an average in OECD countries, 450 days in Malaysia and only 292 days in China. Court costs and attorneys’ fees enhance it to 36% of the value of the claim. In China, the cost is 27% of the claim and on an average in South Asia 26.4%.

Procedures to enforce a contract

There are 56 procedures to enforce a contract in India, only 39 procedures are required to be enforced on an average in South Asia, 32 procedures on an average in East Asia, and 31 procedures in China.

Ease of closing a business Insolvency procedures in India are among the most tedious in South Asia. India gains a rank of 133 on the ease of closing a business. Going through bankruptcy takes 10 years. In South Asia, the time to go through bankruptcy on an average is 4 years, in East Asia it is 2 years and in OECD countries it is one year.

Claims on closing a business

In India, claimants can expect to recover less than 13 cents on the dollar, as compared to an average of 20 cents in South Asia, 18 cents in SubSaharan Africa, 32 cents in China and 93 cents in Japan, which is the highest in the world.

Further, are the government's opaque policies: •

absence of clarity relating to norms for acquiring agricultural land for setting up industrial units, especially those located in special economic zones or export-oriented localities where industrial ventures receive tax concessions as well as regulations for inviting foreign investment in retail concerns.

• Over the coming decade or so, India needs to invest at least 150 billion dollars for improving its infrastructure and a similar amount on retail ventures if the economy is to continue to grow at 8 percent each year.

MODES OF ENTRY INTO INTERNATIONAL BUSINESS

MODES OF ENTRY EXPORTING:DIRECT EXPORTS ,INDIRECT EXPORTS, INTRACORPORATE TRANSFERS

DECISION FACTORS OWNERSHIP ADVANTAGES LOCATION  ADVANTAGES INTERNALISATION  ADVANTAGES OTHER FACTORS: NEED FOR  CONTROL RESOURCE  AVAILABILITY GLOBAL STRATEGY

INTERNATIONAL LICENSING

INTERNATIONAL FRANCHISING

SPECIALISED MODES: MANAGEMENT CONTRACTS, TURNKEY  PROJECTS FOREIGN DIRECT CONTRACTS: GREENFIELD STRATGEY, ACQUISITION  STRATEGY, JOINT VENTURE

European Acquirers – Indian Targets Sectoral Split Telecom 17%

• Telecom – Vodafone’s € 10.5bn announced acquisition of Hutch’s 67% stake in Hutchison Essar – In 2005, Vodafone also picked up 6% stake in Bharti Airtel for € 686m

Transport 3% Chemicals & Materials 6%

Mining 24%

IT& ITeS 7%

• Mining – UK based Vedanta Resources’ recent announced acquisition of 71% stake in Sesa Goa for € 972m

• Cement – Swiss cement major, Holcim picked up 20% stake in Gujarat Ambuja Cement for € 466m

Others 7% Cement 23% Consumer 13%

Source: Merger Market, Rothschild analysis Note:1) Includes all announced deals from 2004 till 2007 YTD 2) Excludes Vodafone – Hutchison Essar deal

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European Acquirers – Indian Targets Top 10 Deals (2005 – 2007YTD) Year

Acquirer

Country

Target

2007

Vodafone Group PLC

UK

Hutchison Essar (67%)

2007

Vedanta Resources PLC UK

Sesa Goa (71%)

972

2005

Vodafone Group PLC

UK

Bharti Airtel (6%)

686

2006

Holcim Ltd

Switzerland Gujarat Ambuja (20%)

2005

Michael Huber Muenchen Germany

2004

Hewlett-Packard Leiden

Netherlands Digital Globalsoft (49%)

245

2005

Holcim Ltd

Germany

Ambuja Cement (67%)

182

2005

SABMiller PLC*

UK

Shaw Wallace

108

2006

Ciments Francais

France

Zuari Cement (50%)

100

2004

DHL Worldwide SA

Belgium

Blue Dart (68%)

Micro Inks Ltd (71%)

Deal Value (€ m) 10,507

466 246

97

Source: SDC, Merger Market, Rothschild analysis Note *- Through its Indian Subsidiary, Mysore Breweries

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Foreign Direct Investment (FDI) is defined as "investment made to acquire lasting interest in enterprises operating outside of the economy of the investor." The FDI relationship consists of a parent enterprise and a foreign affiliate, which together form a Transnational Corporation (TNC).

When is FDI Preferable to Trade? • • • •

Transportation costs too high for exporting Tariff and non-tariff barriers very high Lack of excess domestic capacity Scale economies not significant in competitiveness (especially when products are more differentiated) • country-of-origin effects important (preference for local production) • Location specific advantages such as natural resources

Why Do Firms Invest Overseas? • • • • • •

Trade Barriers Labour Market Imperfections Intangible Assets Vertical Integration Product Life Cycle Shareholder Diversification

Labour Market Imperfections Persistent wage differentials across countries exist. This is one on the main reasons MNCs are making substantial FDIs in less developed nations.

Country Hourly Cost $27.37 Germany $21.38 Japan $17.10 France/U.S. $9.06 Israel $5.47 Taiwan $2.57 Mexico

• • • • • • • • • • • • • • • • • • •

El Salvador 1.25 Finland 14 France  9.4 Germany 17.06 Greece  5.92 Guatemala 1.27 India                     0.23 Ireland 14.66 Israel      10.56 Japan 13.34 Jordan 1.41 , Republic of Korea 9.07 Malaysia 2.16 Mauritius 1.25 Mexico 2.49 Netherlands 19.71 New Zealand 10.96 Nicaragua 0.94 Norway 19.73

Intangible Assets • Coca-Cola has a very valuable asset in its closely guarded “secret formula”. • To protect that proprietary information, Coca-Cola has chosen FDI over licensing. • Since intangible assets are difficult to package and sell to foreigners, MNCs often enjoy a comparative advantage with FDI.

Vertical Integration • MNCs may undertake FDI in countries where inputs are available in order to secure the supply of inputs at a stable accounting price. • Vertical integration may be backward or forward: – Backward: e.g. a furniture maker buying a logging company. – Forward: e.g. a U.S. auto maker buying a Japanese auto dealership.

Product Life Cycle • U.S. firms develop new products in the developed world for the domestic market, and then markets expand overseas. • FDI takes place when product maturity hits and cost becomes an increasingly important consideration for the MNC.

Product Life Cycle

Quantity

The U.S. production

exports co

Quantity

Less advanced  countries

New product

imports

ptio m u s n

n

Maturing product

m u s con

p

Standardized product exports

n tio

imports production

New product

Maturing product

Standardized product

Political Impact of FDI • Countries are concerned that MNCs are foreign-policy instruments of home govt. – East India Co. and Great Britain – United Fruit in Central America – Chile and the overthrow of the Allende govt. • Extraterritoriality: when govts apply own laws to firms’ foreign operations • Bribery a big issue (Foreign Corrupt Practices Act, 1977)

Political Impact of FDI • Foreign control of key or sensitive sectors • Undue influence in local politics of foreign country • MNCs can play countries off of each other • Many examples of lobbying efforts by MNCs for policies in favor of foreign countries

Operational Impact of FDI • Technology transferred at prices that are too high or terms too stringent • Inappropriate technology used • Maintain key functions/knowledge at home country to perpetuate dependence of MNCs • Introduce superfluous products that are not useful to society • Expatriates have top management positions

Gross Fixed Capital Formation and FDI • A summary of the total amount of capital invested in factories, stores office buildings • The main asset types are plant & machinery, equipment, vehicles, landimprovements and buildings. • All things being equal, the greater the capital investment in an economy, the more favorable its future growth prospects are likely to be. • FDI helps to develop GFC in countries

• FDI equity flows were US$ 5.5 billion in 2005-06, it increased almost three times to US$ 15.7 billion in 2006-07, representing a growth rate of 184 per cent. In fact, calculating the total FDI inflows into India by international best practices places the total inflow at US$ 19,531 million. • This huge inflow of FDI has in turn reversed the past trend, with FDI inflows overtaking the portfolio investment inflows by almost US$ 5.6 billion in 2006-07, according to the RBI’s report on International Investment Position. • During April-July 2007-08, FDI inflows amounted to US$ 5,614 million as against US$ 2,848 million during the corresponding period last year, recording a growth rate of 97 per cent.

• The principal sources of FDI during August 1991 to June 2007 have been Mauritius (US$ 20,808 million), US (US$ 6,215 million), UK (US$ 3,979 million), Netherlands (US$ 2,789 million), Japan (US$ 2,585 million), Singapore (US$ 2,033 million) and Germany (US$ 1,917 million), accounting for 41.89 per cent, 12.03 per cent, 7.98 per cent, 5.59 per cent, 5.07 per cent, 4.05 per cent and 3.69 per cent, respectively. • The principal sectors attracting FDI during August 1991 to June 2007 have been services (US$ 9,443 million), electrical equipment (US$ 8,964 million), telecommunication (US$ 4,880 million), transportation (US$ 3,856 million), fuels (US$ 2,892 million), chemicals (US$ 2,465 million) and construction (US$ 1,912 million).

Cisco • Networking major Cisco's CEO John Chambers announced a $1.1 billion investment package for India. Chambers said that the company is also considering India as a manufacturing base. • Intel: Intel Corporation said the company would invest more than $1 billion in the next five years to expand its operations in India and in local technology companies.

AMD & SemIndia • SemIndia, a consortium of overseas Indians, plans to invest $3 billion in an advanced semiconductor manufacturing facility in the country with technology from America's Advanced Micro Devices Inc. • SemIndia sees Indian demand for semiconductor chips at $30 billion each year by 2015.

Automobile sector • According to Commerce Minister Kamal Nath, India is an attractive destination for global auto giants like BMW, General Motors, Ford and Hyundai who were setting base in India, despite the absence of specific trade agreements. • The government is also likely to grant special economic zone status and take a re-look at the tax structure for setting up testing centres and manufacturing plants in a bid to make India the automotive hub of the world.

BMW • German automobile major BMW signed a memorandum of understanding with the Tamil Nadu government to establish its car assembly plant at an investment of $38 million in five years. The German group has selected a site in Mahindra World City in Maraimalainagar, near Chennai, to set up its assembly plant. • BMW has selected Chennai as the "best location" for establishing its car assembly plant with an investment of about Rs 180 crore (Rs 1.8 billion) in five years.

Toyota • Global auto giant Toyota is setting up a gearbox manufacturing plant in India to serve the Asian market. Toyota is planning to invest around Rs 387 crore (Rs 3.87 billion) in collaboration with its mini-vehicle making arm Daihatsu. The aim is to develop a compact car for the Indian market. • Besides, Toyota, Honda Motorcycle, Suzuki Motor (Maruti Suzuki) and Kansai Paints are firming up plans to pump in foreign direct investment (FDI) of at least $1.5 billion in the next three years.

Automotive component industry • India's automotive components industry is the most lucrative sector for foreign direct investments.. • Automotive components manufactured in India are of top quality and used as original components for vehicles made by such top international companies as General Motors, Mercedes, IVECO and Daweoo among others. • Japanese and British component manufacturers are already operating joint-ventures in India. American companies which are setting up plants in India include Delphi (an automotive components division of General Motors USA), Delco Electronics, Textron and Magna International of Canada.

Telecom sector • LG Electronics has invested Rs 900 cr (Rs 9 billion) at Ranjangaon, Samsung has planned to set up a mobile manufacturing base in India. • Finnish mobile handset giant Nokia set up a manufacturing plant in Chennai with an investment of up to $150 million to meet the booming demand for its handsets in India. • The Chennai unit will be Nokia's tenth mobile device production facility globally and will roll out India-specific entry level and mid and upper end GSM and CDMA handsets.

Is this trend growth-friendly for India? • At least one out of four people in India live below the internationaldefined poverty line of one U.S. dollar a day. • A ”negative” aspect is that Indian companies are going abroad despite the fact that there is no dearth of investment opportunities within the country. • Ashok Kumar Bhattacharya, managing editor, ”Business Standard” newspaper, points out that ”despite the apparently insatiable hunger for investments in India, the government has failed to put in place non-discretionary, transparent mechanisms for channeling these investments”.

• Proposed SEZs will create economic hardship because they would be built on prime agricultural land, without adequate compensation for farmers, "islands of affluence in a sea of deprivation", aggravating India's already wide regional imbalances. • BBC : there is currently no law to deal with foreign investment by companies that could have links with terrorism. There are also no bars against firms involved in money and drug laundering.

• The Indian economy has grown by an average of 8 percent a year four years in a row, making it one of the fastest in the world. • Manufacturing industry and the services sector have been annually expanding at 10 percent or faster, agriculture has grown by a meager 1.5-2 percent a year. • The secular decline in the share of agriculture sector in GDP continued, with a decline from 24 per cent in 2001-02 to 17.5 per cent in 2007-08.

Strategic Alliances • A strategic alliance is an arrangement between two or more companies to pursue a common business objective. • 'if you can't beat 'em, join 'em', • 'join 'em, and you can beat anybody.‘

Wal-Mart’s experience • Moved into other countries – Growth opportunities at home were becoming constrained – Create value by transferring core skills to markets where indigenous competitors lacked those skills – Preempt other retailers who were expanding globally • Discovered had to change US model – Differences in local taste, preferences and local infrastructure – Change store location, layout and stocking practices – Keep company’s core strategies and operations – emphasize everyday low prices & realize operating efficiencies from world class logistics management and information systems • Benefits – becoming transnational corporation – Enhanced bargaining power with suppliers – Ability to transfer valuable ideas from one country to another – Balance global standardization with local customization

Boeing enlists the support of its Japanese partners to help offset the high development costs of the next generation of Jumbos

British Airways possesses an extensive network of routes throughout Europe and North America due to its partnership with its alliance partner, US Air

With Quantas, British Airways can provide coverage of Australia, Asia and the Pacific

• Visa and Master Card, traditionally arch rivals, entered into an alliance with Microsoft. They together created specifications for secure online transactions oner open networks, the internet, to prevent payment fraud. • TNT, an Australian air express firm, and the post offices of Canada, France, Germany, the Netherlands and Sweden established a joint venture to get quick entry into these markets and to counter competition from federal express, DHL worldwide and United Parcel Service

A complementor • 'if customers value your product more when they have the other player's product than when they have your product alone.‘ - Barry J.Nalebuff and Adam M.Brandenburger, who coined the word 'coopetition' to describe the new world of companies working in alliance. • Co-opetitors abound in information and communications technology, because no company, however mighty, can supply from its own resources all the hardware, software, connections and distribution that customers require - and it's customer needs that drive co-opetition. • Intel and Microsoft are inseparable complementors in the Wintel

Supplier-Customer Alliances • In supplier-customer alliances, the traditional adversaries stop battling over price, and play together to streamline the relationship, thus lowering costs and improving performance. • The benefits flow to both. Such partnering between customers and suppliers enables integrating the whole supply chain to achieve great economies and increase speed • IBM- business alliances- 1990s with over 20,000 relationships worldwide. • Pilkington jointly owns float glass manufacture in Latin America with its deadly European rival, St.Gobain. • When IBM and Toshiba agreed to invest $1.2 billion in a plant, sited in Virginia, to make advanced 64-megabit memory chips, the two were already partners - with each other in a Japanese plant making liquid crystal display panels, and also with Siemens in a project making the great leap forward into 256-megabit memory chips.

Success factors • FOCUS AND DIRECTION: Pharmaceutical giants like SmithKline Beecham have linked arms with relative minnows to enter unfamiliar fields like biotechnology. SmithKline Beecham's necessities included tapping into drug-related research fields, like biotechnology, where it had no position itself. • Pilkington jointly owns float glass manufacture in Latin America with its deadly European rival, St.Gobain. Since alliance with a Japanese competitor was the key to expanding in automotive glass in the US and other markets

Acquisitions • Acquisition of Command Cellular Services in Kolkata by Hutchison from Usha Martin in 2000. • Acquisition of 79.24% stakes of Aircel, Chennai by Sterling group from RPG group for Rs. 210 Crores in 2003. • Acquisition of 48% stakes in Idea cellular by Aditya Birla group from the Tata group in 2005. • Acquisition of Hutch services in India by Vodafone in 2006. • ICICI acquired Bank of Madura : at a time when its own revenues stood at Rs 2,500 crore (Rs 25 billion) and that of the bank at Rs 100 crore (Rs 1 billion.

• Heidelberg Cement , a leading German cement manufacturing company. entered into an agreement for a 50% joint venture with the Indorama Cement Ltd., situated in Mumbai, originally possessed by the Indorama S P Lohia Group. Being one of the best in the world the Heidelberg Cement Company has its bases in different countries. The Heidelberg Cement Company has two manufacturing units in India. A grinding plant in Mumbai and a cement terminal near Mumbai harbor. A clinker plant is coming up in the state on Gujarat

• Holcim Cement signed an agreement of 14.8% take over with the Gujarat Ambuja Cements (GACL). With new products, skilled personnel, superb management, and a outstanding market strategy gives this tie up good edge over the other competitors. Holcim Cement Company, the leading cement manufacturing and supplying companies has a work force of 90,000.The Holcim Cement Company has units in excess of 70 countries all over the world. • Italcementi cement - Zuari Cement Limited Italcementi Cement Company with the help of the Ciments Français, a subsidiary for its global activities, has acquired shares of the famous Indian cement manufacturer - Zuari Cement Limited. The acquisition was of 50% shareholding and the deal was of about 100 million Euros. Italcementi Cement is the 5th largest cement manufacturing company in the world. The production capacity of the Italcementi cement company is about 70 million tons in a year. With the construction boom in India the company looks for a stable future. In 2001 the Italcementi cement entered the Indian market scenario. It took over the plant of the Zuari Cement Limited in Andhra Pradesh in southern India. The joint venture earned revenues of around 100 million Euros and an operating profit of 4 million Euros.

• Lafarge India is the subsidiary of the Lafarge Cement Company of France. It was established in 1999 in India with the acquisition of the Tisco and the Raymond cement plants. Lafarge Cement presently has three cement manufacturing units in India.

Objectives of Session Three • WTO and its impact on India • India’s history with WTO, issues India has agreed on, does not agree and is forced to agree, the reasons why, the stand offs and India’s concerns • Regional economic integrations, how each develop from stage one to the most sophisticated level with examples of the same all over the world

Evolution of the International Monetary System

• • • • •

Bimetallism: Before 1875 Classical Gold Standard: 1875-1914 Interwar Period: 1915-1944 Bretton Woods System: 1945-1972 The Flexible Exchange Rate Regime: 1973Present

Bimetallism: Before 1875 • A “double standard” in the sense that both gold and silver were used as money. • Some countries were on the gold standard, some on the silver standard, some on both. • Both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents.

Classical Gold Standard: 1875-1914

• During this period in most major countries: – Gold alone was assured of unrestricted coinage – There was two-way convertibility between gold and national currencies at a stable ratio. – Gold could be freely exported or imported. • The exchange rate between two country’s currencies would be determined by their relative gold contents.

For example, if the dollar is pegged to gold at U.S.$30 = 1 ounce of gold, and the British pound is pegged to gold at £6 = 1 ounce of gold, it must be the case that the exchange rate is determined by the relative gold contents: $30 = £6 $5 = £1 Highly stable exchange rates under the classical gold standard provided an environment that was conducive to international trade and investment.

WHY NOT NOW?

– The supply of newly minted gold is so restricted that the growth of world trade and investment can be hampered for the lack of sufficient monetary reserves. – Even if the world returned to a gold standard, any national government could abandon the standard.

Interwar Period: 1915-1944 • Exchange rates fluctuated as countries widely used “predatory” depreciations of their currencies as a means of gaining advantage in the world export market. • Attempts were made to restore the gold standard, but participants lacked the political will to “follow the rules of the game”. • The result for international trade and investment was profoundly detrimental.

History • After World War II – Create institutions that would eliminate the causes of war. • Through UN and eliminating the economic causes of war • Bretton Woods Conference of 1944 – Three institutions formed: • The International Monetary Fund (IMF) • The World Bank • The International Trade Organization (ITO)

Bretton Woods System: 1945-1972 • Named for a 1944 meeting of 44 nations at Bretton Woods, New Hampshire. • The purpose was to design a postwar international monetary system. • The goal was exchange rate stability without the gold standard. • The result was the creation of the IMF and the World Bank.

• Under the Bretton Woods system, the U.S. dollar was pegged to gold at $35 per ounce and other currencies were pegged to the U.S. dollar. • Each country was responsible for maintaining its exchange rate within ±1% of the adopted par value by buying or selling foreign reserves as necessary. • The Bretton Woods system was a dollar-based gold exchange standard.

The Flexible Exchange Rate Regime: 1973-Present • Flexible exchange rates were declared acceptable to the IMF members. – Central banks were allowed to intervene in the exchange rate markets to iron out unwarranted volatilities. • Gold was abandoned as an international reserve asset. • Non-oil-exporting countries and less-developed countries were given greater access to IMF funds.

Current Exchange Rate Arrangements • Free Float – The largest number of countries, allow market forces to determine their currency’s value. • Managed Float – About 25 countries combine government intervention with market forces to set exchange rates. • Pegged to another currency – Such as the U.S. dollar or euro (through franc or mark). • No national currency – Some countries do not bother printing their own, they just use the U.S. dollar. For example, Ecuador has recently dollarized.

THE  INTERNATIONAL  BANK  FOR  RECONSTRUCTION  &  DEVELOPMENT  (IBRD):   The official name for the IBRD & the International Finance Corporation is the world bank. Established in 1945, the World Bank’s initial goal was to help finance reconstruction of the war –torn european economies. with the assistance of the Marshall Plan, the World Bank accomplished this task by the mid 1950’s.

Then the bank adopted the new mission of building the economies of the world developing countries. As its mission has expanded over time, the world bank created four affiliated organizations: 1.INTERNATIONAL DEVELOPMENT ASSOCIATION (IDA) 2.THE INTERNATIONAL FINANCE CORPORATION (IFC) 3.THE MULTILATERAL INVESTMENT GUARANTEE AGENCY (MIGA) 4.THE INTERNATIONAL CENTER FOR SETTLEMENT OF INVESTMENT DISPUTES (ICSID).

INTERNATIONAL  DEVELOPMENT  ASSOCIATION (IDA) IDA offers soft loans, loans that bear some significant risk of not being repaid. its lending efforts focuses on the least –developed countries a typical loan is the us $92 million provided to improve rural water suppliers to 1200 villages (total population-4.8 million) in Karnataka.

The  International  Finance  Corporation (IFC): IFC was created in 1956 & is charged with promoting the development of the private sector in developing countries acting like as investment banker. The IFC, in collaboration with private investors, provides debt & equity capital for promising commercial activities

The  Multilateral  Investment  Guarantee  Agency (MIGA): In 1988 the WB affiliate MIGA was set up to overcome private –sector reluctance to invest in developing countries because of perceived political riskiness. MIGA encourages direct investment in developing countries by offering private investors insurance against non-commercial risks.

The  International  Center  for Settlement of Investment  Disputes (ICSID):   ICSID was founded in 1996 to promote increased flows of international investments by providing facilities for the conciliation & arbitration of disputes between Government & Foreign investors. ICSID also provides advice, carries out research & produces publications in the area of foreign investment law.

INTERNATIONAL MONETARY FUND

To ensure that the post-second world war monetary system would promote international commerce, the bretton woods agreement called for the creation of the IMF to oversee the functioning of the international monetary system.

WTO

The WTO is merely a smoke-screen for global domination of multinationals

General Agreement on Tariffs and Trade (GATT) • Congress refused to agree to the ITO – Cede too much sovereignty to an international body. • General Agreement on Tariffs and Trade—1947 – Provisional agreement for the ITO – Became the agreement and the organization for establishing and enforcing, through dispute settlement, the international trade rules.

The World Trade Organization • The Uruguay Round (8th)—1984-1995 – established the World Trade Organization – amended GATT 1947 which became GATT 1994 • Became the World Trade Organization (WTO) on January 1, 1995

Mission • Increase international trade by – promoting lower trade barriers – providing a platform for the negotiation of trade • “...In brief, the World Trade Organization (WTO) is the only international organization dealing with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as possible.”

Structure • Highest level: Ministerial Conference – Meets at least every two years – Comprised of countries or customs unions – Makes decisions on all matters under any of the multilateral trade agreements

Structure (cont.) • Second level: General Council – Handles the daily work of the ministerial conference along with the Dispute Settlement Body and the Trade Policy Review Body – Consists of representatives of all WTO member states

Structure (cont.) • Third level: Councils for Trade – Work under the General Council • Three parts – Council for Trade in Goods – Council for Trade-Related Aspects of Intellectual Property Rights – Council for Trade in Services • Six other bodies report to the General Council – trade and development – the environment – regional trading arrangements – administrative issues.

Structure • Fourth level: Subsidiary Bodies – Three bodies • The Goods Council—11 committees – agriculture, market access, subsidies, anti-dumping measures, etc. • The Services Council – financial services, domestic regulations and other specific commitments • Dispute Settlement panels and Appellate Body – resolve disputes – Appellate Body deals with appeals

Principles of Trading 1. Free of discrimination – Cannot privilege a particular trading partner above others within the system – Cannot discriminate against foreign products and services. 2. Tend toward more freedom – fewer trade barriers (tariffs and non-tariff barriers) 3. Predictable – trade barriers will not be raised arbitrarily – markets will remain open. 4. Tend toward greater competition 5. More accommodating for less developed countries – Give them more time to adjust, greater flexibility, and more privileges.

Agreements • Approximately 30 agreements exist • Agreements are (officially) made by consensus of all member countries – Finds the most widely acceptable decision – Time consuming • In reality, agreements are often made in informal “Green Room” or “Mini-ministerial” meetings with some nations not being present

Agreement on Agriculture (AoA) • Domestic support – Green box- fixed payments for environmental programs – Amber box- general subsidies – Blue box- production-limiting subsidies • Market access – Developed countries- reduce tariffs by 36% – Developing countries- reduce tariffs by 24% • Export subsidies – Reduce tariffs by 35%

General Agreement on Trade in Services (GATS) • Prior to the GATS there was no agreement with regard to trade in services • Historically many services (e.g. health, education) have been considered the responsibility of government • With GATS many services have opened up to international trade that were previously monopolized by governments

Trade-related Aspects of Intellectual Property Rights (TRIPs) • Sets forth minimum intellectual property standards for member countries • Protected items include copyrights, geographical indications, industrial designs, chip designs, patents, trademarks, trade dress, and confidential information

Sanitary and Phyto-Sanitary Agreement (SPS) • Sets food safety standards – Bacterial contaminants – Pesticides – Inspection and labeling • Animal and plant health – Imported pets – Diseases

Agreement on Technical Barriers to Trade (TBT) • Ensures “that technical negotiations and standards, as well as testing and certification procedures, do not create unnecessary obstacles to trade”

Doha Round Began November 2001

WTO @ Cancun

Hong Kong • • • •

Billed as a “Development Round” Agreement to phase out all agricultural export subsidies by 2014 Terminate cotton subsidies by 2007 Developing nations again see this round as a loss.

WTO Advantages • Helps trade to flow smoothly. • Deals with disputes over trade. • Decisions in the WTO are made by consensus and the agreements apply to everyone. • All countries can appeal against decisions which they feel are unfair. This system has the potential to protect developing countries from harsh measures and unfair rules.

WTO Criticisms 1. The WTO only serves the interests of multinational corporations and wealthy nations. 2. Fundamental principals and aims of the WTO are not beneficial for all parties involved. 3. The WTO tramples over labor and human rights 4. The WTO is destroying the environment. 5. Fundamental principals and aims of the WTO are not beneficial for all parties involved. 6. The US adoption of the WTO undemocratic. 7. The WTO undermines local development and penalizes poor countries. 8. The WTO is increasing inequality.

“Some examples of this bias are: (1) rich countries are able to maintain high import duties and quotas in certain products, blocking imports from developing countries (2) the increase in non-tariff barriers such as antidumping measures allowed against developing countries; (3) many developing countries do not have the capacity to follow the negotiations and participate actively in the Uruguay Round; and (4) the TRIPS agreement which limits developing countries from utilizing some technology that originates from abroad in their local systems.” - Martin Khor

REGIONAL ECONOMIC INTEGRATION

Economic Integration ➲ A group of countries come together and agree to cooperate in international trade by various means. ➲ Mainly economic advantages. ➲ Trade creation and trade diversion, reduced Import Prices, Increased competition and economies of scale, Higher factor Productivity. ➲ Political Factors and power in international markets.

Levels of Economic Integration. ➲ ➲ ➲ ➲ ➲ ➲

Regional Cooperation Groups. Free trade areas. Full customs union. Common market. Economic union. Political union.

Regional Cooperation Groups. ➲ ➲ ➲ ➲

Cooperate to develop basic industries like steel, hydro-electricity etc. Joint ventures, pooling of technologies/resources. Mainly less developed countries. No effect on trade or tariff barriers.

➲ For Example - A.S.E.A.N. Brunei, Burma, Cambodia, Indonesia, Laos, Malaysia, the Philippines, Singapore, Thailand and Vietnam

➲ The South Asian Association for Regional Cooperation (SAARC) Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and SriLanka.

ASEAN

Free Trade Areas. ➲ ➲ ➲ ➲ ➲ ➲

No Internal Tariffs. External Tariffs could be different. Cooperation on economic issues. No free labor or capital movements. N.A.F.T.A. -U.S.-Israel, European Free Trade Area

Full Customs Union. ➲ No Internal Tariffs. ➲ Common External Tariffs. ➲ No Free labor or capital movements. ➲ Usually a small country close to a large one. ➲ France-Monaco ➲ Italy-San Marino.

Common Market. ➲ No Internal Tariffs. ➲ Common External Tariffs. ➲ Free flow of labor and capital. ➲ Southern Cone Common Market (Mercosur) - Argentina, Brazil, Paraguay, Uraguay, Bolivia, and Chile. ➲ Caribbean Community and Common Market.

Economic Union. ➲ ➲ ➲ ➲ ➲ ➲ ➲

No Internal Tariffs. Common External Tariffs. Free flow of labor and capital. Integration of economic policies. Harmonize monetary policies, taxation, and government spending. Common currency or fixed exchange rates. E.U. - Full monetary union by 1999 and single European currency by 2002.

Political union Political union – Involves complete political and economic integration, either voluntary or enforced. – Commonwealth – a voluntary organization providing for the loosest possible relationship that can be classified as economic integration. – Two new political unions came into existence in the 1990s: • The Commonwealth of Independent States (CIS) • The European Union (EU)

EU Institutions. • The European Commission - Executive branch, commissioners oversee 23 directorates such as agriculture, transportation, etc. • Council of Ministers- votes based on country size, final power to decide EU actions. • European Parliament - 626 members elected by popular votes in member countries, advisory body with very little power. • European Court of Justice - Judicial branch, mainly matters related to trade and business disputes.

The Commonwealth of Independent States • The remaining 12 republics of the former USSR after the aborted coup against Gorbachev and the formation of the Baltic States. • The CIS is a loose economic and political alliance with open borders but no central government. • The 12 members of the CIS share a common history of central planning, and their close cooperation could make the change to a market economy less painful, but differences over economic policy, currency reform, and control of the military may break them apart.

Commonwealth of Independent States (CIS) • Exhibit 10.6

Latin America. • Economic and trade liberalization. • Deregulation, Privatization and control of inflation. • Almost every country in Latin America has either signed some type of trade agreement or is involved in negotiations. • Latin American Integration Association • Caribbean Community and Common Market (CARICOM) • NAFTA to FTAA or SAFTA?

Far Eastern Market Group • Insert Exhibit 10.9

APEC - Asia Pacific Economic Cooperation The Asia-Pacific Economic Cooperation forum is a loose grouping of countries bordering the Pacific Ocean who have pledged to facilitate free trade and economic cooperation • Its 21 members range from China and Russia to the United States, Japan and Australia, and account for 45% of world trade.

03/09/98

Africa • The Economic Community of West African States (ECOWAS) and the Southern African Development Community (SADC) are the two most active regional cooperative groups. – ECOWAS continues to be plagued with financial problems, conflict within the group, and inactivity on the part of some members. • The Southern African Development Community is the most advanced and viable of Africa’s regional organizations.

Middle East • Economic Cooperation Organization (ECO) • Creation of the Organization of the Islamic Conference (OIC) – Represents 60 countries and over 650 million Muslims worldwide – The member countries’ vast natural resources, substantial capital, and cheap labor force are seen as the strengths of the OIC.

OPEC • The Organization of the Petroleum Exporting Countries (OPEC) is a permanent, intergovernmental Organization, created at the Baghdad Conference on September 10–14, 1960, by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. The five Founding Members were later joined by nine other Members: Qatar (1961); Indonesia (1962); Socialist Peoples Libyan Arab Jamahiriya (1962); United Arab Emirates (1967); Algeria (1969); Nigeria (1971); Ecuador (1973–1992); Gabon (1975–1994) and Angola (2007).

OPEC • OPEC was to rival the supposedly seven sister multinational oil companies because developing country oil exporters sensed that they were being exploited by Western governments and their multinational corporations, who drilled their oil and marketed it as well. • OPEC’s objective was to co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.

• In 1973 the U.S. and the Western world were caught in the whorl of inflation and this made them vulnerable to commodity cartels. • The preceding twenty years had seen prosperity and increase in the growth of population, which created heavy demand for raw materials. • In the U.S., consumer prices were rising at an average rate of 8.5 per cent, with even higher inflation rates in other countries. • The oil sold by the Gulf nations had therefore much more demand than before and had grown beyond the capacity of supply and oil production.

• When President Nixon put controls on oil, the U.S., which had been self sufficient in energy till the year 1950, was importing 35 per cent of its energy needs in March 1973. • The so far discovered petroleum reserves of the US were almost depleted. On October 6, 1973, on the Jewish holy day of Yom Kippur, Egyptian forces attacked Israel from across the Suez Canal. • Simultaneously, Syrian troops attacked the Golan Heights in a surprise manouvre. Israel, was supported by the US in their effort, which was disliked by the countries of the OPEC. On October 17, OPEC imposed an oil embargo on the U.S. and increased prices by 70 per cent to America's Western European allies. • This raised the price of a barrel of oil to these nations from USD 3 to USD 5.11 and it was further raised to USD 11.65.

The functioning of oil markets • The major markets are in London, New York and Singapore but crude oil and its refined products, such as gasoline (petrol) and heating oil are procured and put on the market all over the world. Crude oil is found in several ranges and qualities, classified as per its specific gravity and sulphur content. The variety and quality also depends on where the crude oil has been drilled from.

• Brent is used to price two thirds of the world's internationally traded crude oil supplies as per IPE reports. Dubai crude is used as a benchmark to price sales of other regional crudes into Asia in the Gulf region • In the United States, the benchmark is West Texas Intermediate (WTI) meaning, crude oil sales into the US are usually priced in comparison to WTI. Crude oil prices on the New York Mercantile Exchange normally refer to light, sweet crude, which may be any US domestic or foreign crudes but will have a specific gravity and sulphur content within a certain range.

• The basket price index is currently composed of the following 11 OPEC crude oils: Algeria's Saharan Blend, Indonesia's Minas, Iran's Iran Heavy, Iraq's Basra Light, Kuwait's Kuwait Export, Libya's Es Sider, Nigeria's Bonny Light, Qatar's Qatar Marine, Saudi Arabia's Arab Light, United Arab Emirates' Murban and Venezuela's BCF 17.

Who's in the dock for the financial turmoil? Several categories of individuals and institutions stand accused.

SUB-PRIME LENDERS • The root of much of the current difficulties lies in the sub-prime loans market, predominantly in the US. The sub-prime category refers to the category of borrowers at the highest risk of defaulting on their loan perhaps those with a poor credit history or unreliable income. • "The poorest people pay the highest interest rates," he says. In the low interest rate years after 2001, sub-prime borrowers might pay two or three times the interest of a prime borrower.

• And if some defaulted, it wasn't the end of the world. Property prices were rising so fast in the US that the odd repossession wasn't a major problem. In an atmosphere of speculation, many people saw there was money to be made in property and so the spiral continued. • But when the housing market took a turn for the worse, the problems started. Many borrowers were on deals that for the first two years had low rates and then switched to a much higher rate. Once house prices fell, borrowers who were struggling started defaulting on loans. Repossessed houses flooding onto the market caused a vicious circle. • By April this year, the FBI was already investigating 19 allegations of corporate fraud relating to sub-prime loans.

THE INVESTMENT BANKSArchitects of their own misery? • If it was just a case of sub-prime lenders suffering a rash of defaults, then the layman might assume that the damage would be limited to those lenders - like IndyMac and New Century - that have collapsed. • But these sub-prime loans were parcelled up and turned into complex financial products traded on markets all over the world. The esoteric nature of some of the products related to these loans has been blamed by many for the extent of the crisis.

WHAT IS SHORT-SELLING? • • • • • •

Short seller borrows share Sells share on market Share price falls Short seller repurchases share Share returned to original owner The price difference is mostly profit

A short seller effectively bets on the price of an asset, often a share, falling. Typically this is done by borrowing the share from the owner. The share is then sold and when the price drops it is repurchased and returned to the original owner. The short seller pockets the difference. A key issue is the opacity of the banking system. If no-one can truly assess the liabilities of a given financial institution, how can they confidently lend it money? But this has helped people make money.

THE GREAT DEPRESSION  1929

Photos by photographer Dorothea Lange

THE NATION’S SICK ECONOMY As the 1920s advanced, serious problems threatened the economy while Important industries struggled, including:

• • • • • • • • •

Agriculture Railroads Textiles Steel Mining Lumber Automobiles Housing Consumer goods

FARMERS STRUGGLE • No industry suffered as much  as agriculture • During World War I  European demand for  American crops soared • After the war demand  plummeted • Farmers increased production  sending prices further  downward Photo by Dorothea Lange

CONSUMER SPENDING DOWN

• By the late 1920s, American  consumers were buying less • Rising prices, stagnant wages  and overbuying on credit were  to blame • Most people did not have the  money to buy the flood of  goods factories produced

GAP BETWEEN RICH & POOR

• The gap between rich and  poor widened • The wealthiest 1% saw their  income rise 75% • The rest of the population  saw an increase of only 9% • More than 70% of American  families earned less than  $2500 per year

Photo by Dorothea Lange

THE STOCK MARKET  • By 1929, many Americans had  invested in the Stock Market • The Stock Market had become  the most visible symbol of a  prosperous American economy • The Dow Jones Industrial  Average was the barometer of the  Stock Market’s worth  • The Dow is a measure based on  the price of 30 large firms 

STOCK PRICES RISE THROUGH  THE 1920s • Through most of the 1920s,  stock prices rose steadily • The Dow reached a  high in  1929 of 381 points (300 points  higher than 1924) • By 1929, 4 million Americans  owned stocks 

New York Stock Exchange

SEEDS OF TROUBLE • By the late 1920s, problems  with the economay emerged • Speculation: Too many  Americans were engaged in  speculation – buying stocks &  bonds hoping for a quick profit • Margin: Americans were  buying “on margin” – paying a  small percentage of a stock’s  price as a down payment and  borrowing the rest

The Stock Market’s bubble was about to break

THE 1929 CRASH

• In September the Stock Market  had some unusual up & down  movements • On October 24, the market took  a plunge . . .the worst was yet to  come • On October 29, now known as  Black Tuesday, the bottom fell  out • 16.4 million shares were sold  that day – prices plummeted • People who had bought on  margin (credit) were stuck with  huge debts

By mid-November, investors had  lost about $30 billion

THE GREAT DEPRESSION • The Stock Market crash  signaled the beginning of the  Great Depression • The Great Depression is  generally defined as the period  from 1929 – 1940 in which the  economy plummeted and  unemployment skyrocketed • The crash alone did not cause  the Great Depression, but it  hastened its arrival

FINANCIAL COLLAPSE • After the crash, many Americans panicked and withdrew their money from banks • Banks had invested in the Stock Market and lost money • In 1929- 600 banks fail • By 1933 – 11,000 of the 25,000 banks nationwide had collapsed

Bank run 1929, Los Angeles

GNP DROPS, UNEMPLOYMENT  SOARS • Between 1928-1932, the U.S.  Gross National Product (GNP)  – the total output of a nation’s  goods & services – fell nearly  50% from $104 billion to $59  billion • 90,000 businesses went  bankrupt • Unemployment leaped from 3%  in 1929 to 25% in 1933

CAUSES OF THE GREAT  DEPRESSION • Tariffs & war debt  policies • U.S. demand low, despite  factories producing more • Farm sector crisis • Easy credit • Unequal distribution of  income

Will History repeat itself….

?

The Mexican Peso Crisis • On 20 December, 1994, the Mexican government announced a plan to devalue the peso against the dollar by 14 percent. • This decision changed currency trader’s expectations about the future value of the peso. • They stampeded for the exits. • In their rush to get out the peso fell by as much as 40 percent.

• The Mexican Peso crisis is unique in that it represents the first serious international financial crisis touched off by cross-border flight of portfolio capital. • Two lessons emerge: – It is essential to have a multinational safety net in place to safeguard the world financial system from such crises. – An influx of foreign capital can lead to an overvaluation in the first place.

The Asian Currency Crisis • The Asian currency crisis turned out to be far more serious than the Mexican peso crisis in terms of the extent of the contagion and the severity of the resultant economic and social costs. • Many firms with foreign currency bonds were forced into bankruptcy. • The region experienced a deep, widespread recession.

Currency Crisis Explanations • In theory, a currency’s value mirrors the fundamental strength of its underlying economy, relative to other economies. In the long run. • In the short run, currency trader’s expectations play a much more important role. • In today’s environment, traders and lenders, using the most modern communications, act by fight-or-flight instincts. For example, if they expect others are about to sell Brazilian reals for U.S. dollars, they want to “get to the exits first”. • Thus, fears of depreciation become self-fulfilling prophecies.

Financial crisis: World round-up A look at the regions of the world most affected by the financial crisis, and what governments are doing to try to alleviate the financial turmoil.

JOINT ACTION The International Monetary Fund said it was ready to lend to countries hit by the credit crunch, using an emergency funding mechanism first used in the 1990s Asian financial crisis. The US Federal Reserve, the European Central Bank, the Bank of England, and the central banks of Canada, Sweden and Switzerland took the unprecedented step on 8 October of co-ordinating a halfpoint cut in interest rates in an effort to ease the credit crunch. On 13 October, the 15 countries in the eurozone agreed a joint plan to guarantee loans between banks, and provide government capital to protect ailing financial institutions.

Have bail-outs worked in the past?

The US is pinning its hopes on a $700bn  (£395bn) bail-out of the banking sector.

The plan's supporters argue that it is important to bail out banks - as opposed to other failing industries - because of the knock-on effects a bust bank can have on the economy. Banks can also fail for irrational reasons, which non-financial companies are less likely to do. A perfectly sound bank could fail just because its customers panic and all ask for their money on the same day.

US AIRLINE SECTOR 2001

The airline industry faced collapse after the terrorist attacks of 11 September. United was one of the airlines worst affected by 9/11. Carriers faced immediate problems when a flying ban was imposed and people were afraid to fly. The US government provided compensation. But once flights resumed, the airlines faced a problem that is now familiar to banks: they could not get credit. The government set up the Air Transport Stabilization Board to provide up to $10bn (£5.66bn) in loan guarantees. The government received shares in the airlines in return for guaranteeing loans to them and also charged fees for participating in the scheme. "The bottom line is that the programme did its job," says Professor Leighton Vaughan Williams from Nottingham Business School. "Taxpayers eventually made a profit of $300m," he adds. It was not an easy time for airlines and several such as United Airlines were forced to seek bankruptcy protection, but most of them survived.

THE BRITISH EXPERIENCE 1970s

• Bailing out or nationalising big manufacturers is not as popular as it once was. Advocates of bail-outs arged that if "a company had a strong future but was experiencing temporary difficulties, that would be solved by an injection of taxpayers' money," says Professor Naresh Pandit from Norwich Business School. "The idea was that the government could later withdraw, but it never did as planned." • British Leyland was effectively nationalised with a cash injection in 1975 and, despite owning marquees that still exist today, the company itself and the British carmaking industry never really recovered.

• Rolls-Royce was nationalised in 1971, a bail-out which worked better in the long run than the British Leyland deal. • The company had run into difficulties due to cost-overruns in the development of its RB211 engine. It spun off its carmaking division in 1973, but the rest of the company remained in government control until 1987, when it was privatised. Rolls-Royce is now a successful company, but many people argue that it spent too long in government hands. "There is strong evidence that nationalisation leads to lower efficiency," says Professor Pandit.

SAVINGS AND LOANS 1980s and 1990s

America's savings and Loans companies were similar to building societies in Britain and were often owned by their customers. The US Savings and Loan (S&L) crisis of the 1980s and 1990s was partly caused by institutions lending more money in home loans than was prudent and then getting hit by rising interest rates, which will sound familiar to observers of the current crisis. Fraud was also a big factor.

The government set up the Resolution Trust Corporation (RTC) to take over the hundreds of failed S&Ls and try to sell their assets. "The bail-out cost about $300bn in today's money and when the RTC sold the assets, it made back about 80% of what it paid," says Professor Vaughan Williams. "To get back 80% on what were bankrupt assets could be called a success."

THE EARLY BAIL-OUTS 1792 Bailing out banks is certainly not a new idea, with the first US bank bail-out taking place in 1792. William Duer tried to corner the market in government bonds and depress the share price of the Bank of New York. His plan went wrong, causing market panic. With the value of bonds collapsing, the first Treasury Secretary Alexander Hamilton told banks to accept bonds as collateral for loans, which were then underwritten by the government. He also borrowed money from banks and used it to buy government bonds. Prices recovered and all the banks involved survived.

In marked contrast, President Andrew Jackson in the 1830s was widely blamed for bringing about the demise of the Second Bank of the United States when he refused to deposit tax revenues in it. The collapse of the bank was one of the causes of the Panic of 1837 in which the next president, Martin van Buren, refused to involve the government. Milton Friedman described the depression that followed as the only one comparable with the Great Depression of the 1930s.

What do market moves mean for you

• Traders are not the only ones worried about the falls. The fluctuations of share prices affect all of us - often in a more direct way than consumers realise. • At the start of trading on Friday the FTSE 100 share index plunged about 10%, falling below 4,000 points for the first time in five years. • There were also falls across the world - in France, Germany, Australia, Hong Kong, Singapore and Russia, as well as in Tokyo and on Wall Street.

• The "ripple effect" of a downturn in the market has an effect on house prices, says Mr Halling. • As well as traders becoming less wealthy and so less likely to buy homes, the shrinking possibility of borrowing and less job security also slows down the housing market. • In recent years, employees might have been paid bonuses in shares. People might have held onto shares handed out to customers when building societies demutualised in the late 1990s.

• Any share-based investments such as shares ISAs or endowment policies will have been cut in value. There are worries for people who use endowment policies to pay off their mortgage. • But trying to cash them in early will cost you money. • It is always worth remembering that investments are very different from savings in a bank account - they can go down in value as well as up, especially in the short-term. • Perhaps most affected by this latest slump are those who are set to retire soon.

What about pensions? • Some 60% of an average pension fund is invested in shares. • People with personal pensions and on the cusp of retirement will be pulling money out of the stock market in order to buy an annuity - your income in retirement. • Tom McPhail, head of pensions research at Hargreaves Lansdown, says that those buying an annuity now will have an annual sum until death that is 15% less than it would have been a month ago.

• This could lead people to delay their retirement. • The latest you can leave it to buy an annuity is the age of 75. The government says it may consider a temporary suspension of this deadline so people of that age can wait for their funds to recover. • Others have pensions in a final salary scheme. They are safe because their employer covers the risk. • But over the long-term, if the markets continue to struggle, employers may be quicker to close down these schemes to new members.

Any other long-term effects? • Children born in the UK after September 2002 have a nest-egg being saved for them in Child Trust Funds. • These funds, which began operating in April 2005, will now probably be worth less than they were if they haven't been topped up by parents. But youngsters cannot get their hands on them until they are 18, and so by then they may have grown in value.

Is that the same with all investments? • Financial advisers always say that investments should be for the long term even though, as Dane Halling says "we do not know what is on the other side of the valley". Most people's funds are spread across a series of stocks in order to protect them if one plunges further than others. • Jason Butler says that people can "rebalance" where these funds are invested, but ultimately they will recover if investments are left for a number of years. He points to the experiences of the late 1970s. If somebody invested £100 in shares on the London Stock Exchange in 1973, it would have only been worth £34 by the end of 1974. • But around four years later it would have been back in positive territory and by 1982, it would have been worth £300. "It is the fool who jumps," says Mr Butler.