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smu assignment solved for Q.2 Discuss the impact of economic environment on international business.


Economic Environment
The economic environment refers to the conditions under which a business operates and takes into account all factors that have affected it. It includes prime interest rates, legislation concerning employment of foreigners, return of profits, safety of country, political stability and so on.

National economic policies depend on that country’s socio-economic and cultural background. All governments aspire to achieve four major economic objectives:
·         Full employment.
·         A high economic growth rate.
·         A low rate of inflation.
·         Absence of deficit in the country’s balance of payments.

The basic problem is that the first two objectives work against the last two. Measures such as low interest rates, tax cuts and increase in public spending creates jobs and stimulates growth but also causes inflation, increase in wage, and higher imports. Due to increased consumer expenditure the country’s balance of trade worsens.
So the issue lies in balancing the effects of the policies to achieve the four given objectives.

Foreign Direct Investment (FDI) Policy
Foreign direct investment (FDI) is an investment made with an intention of establishing a long term interest by a business enterprise in another country. It is also required that such an enterprise holds directly or indirectly, an ownership of 10% or more of voting rights in the target enterprise.
FDI policy, which is dictated by the Government of the host country, plays a vital role in the economic growth of that country. Attracting FDI inflows with constructive policy is a challenge for any nation. Developing countries offer a lot of incentives for FDI, particularly in capital intensive sectors like power, infrastructure, transport, construction. Effective FDI policies help the host country to portray itself as an attractive investment destination.
Main objectives of FDI policy are to provide and facilitate investor friendly business environment, so that the foreign investors feel safe with the financial and legal framework of the country. The Government of the host countries often formulate new or special regulatory framework to attract FDI. The host country often needs to invest in development of domestic infrastructure to make it investor friendly.

2. Economic structure
IB managers need to understand and assess international economic forces at work. Key variables that need to be examined include Gross Domestic Product (GDP) per capita, regional distribution of GDP, levels of investment, consumer expenditure, labour costs, inflation and unemployment. Variables that are examined when assessing national economic environments include:

Economic structure – The structure of a nation’s economy is determined by the size and rate of its population growth, income levels and distribution of income, natural resources, agricultural, manufacturing and services sector. Economic infrastructure is the sum of all the external facilities and services that support the work of firms including communication, transportation, electricity supply, banking and financial services.

Industry structure – The structure of an industry is determined by factors such as:
· Entry and exit barriers.
· Number of competing firms.
· Market share among firms in that sector.
· Average size of competing units.

Market growth – It is measured in terms of local currency and adjusted for inflation. Local currency is used because conversions into other currencies are affected by exchange rate fluctuations.

Income levels – It is taken as the Gross Domestic Product (GDP) per capita and GDP is directly proportional to the productivity of the country. Net income is another important variable and is without tax payments from individual gross incomes.

Sector wise trends – Growth activity in a country might vary significantly among certain industries. For example, India has a vibrant software services industry.

Openness of the economy – The ratio of a country’s imports and exports to its Gross National Product (GNP) indicates its vulnerability to fluctuations in international trade. A nation with a high foreign trade or GNP depends heavily on the economic well-being of the nations it exports to. Conversely, closed economies have a high degree of control of the economy.

International debt - The comparison of a nation’s obligations to service and repay foreign debt with its forex earnings shows its ability to remain solvent. On the other hand, a high foreign debt servicing requirement maybe a positive indicator, suggesting that a country has borrowed heavily to invest in its future.
Degree of urbanisation - This is an important factor because in most countries there are important differences in incomes and lifestyles between urban and rural areas. Major dissimilarities are:
· Shopping patterns - shopping frequency, average purchase value.
· Nature of goods bought.
· Expectations in quality and technical sophistication.
· Education levels.
· Ease of distribution.

3. Balance of payments
Importance - Balance of payments is a record of all transactions that occur between residents of that country and foreigners over a specific period of time. The balance is shown monthly, quarterly or annually. The accounts show the structure of the external trade, net position as a lender or borrower and trends in economic relationships with the world.

The balance of payments is a good overall indicator of its economic health; the likelihood of the country’s government imposing forex controls, import restrictions and policies such as tax increases and interest rate hikes.

Balance of payment account - These accounts attempt to identify the reasons behind various categories of international receipts and payments, making it possible to establish the values of payments by domestic residents to foreigners, and vice versa, for purchase of imports, use of services, lending, or direct foreign investment.

The account is divided into categories for long and short term financial transactions which is initiated by the national monetary body, and involves goods and services.

Deficits and surpluses - Current account deficit, records physical imports and exports along with international transactions in invisibles, that is non-physical items such as residents’ pensions, interest and royalties from abroad, domestic firm’s fees for the movement of goods in other countries, and so on. The balance of trade within the current account is the balance on physical (visible) imports and exports.

The other major grouping is the capital account which shows the balance of transactions in financial assets, including direct investments in foreign financial instruments, movements in short-term assets, inter-governmental loans and changes in the country’s gold and forex reserves.

Reserves will decline if there is, for example, a current account deficit which in turn affects the currency rate. To prevent the local currency from depreciating too far, some foreign currency reserves will be sold, but since it is limited, this is only a temporary measure.

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