Exchange rate

Exchange rate

Exchange rate is the price of one currency in terms of another currency.

Exchange rates can be either fixed or floating. Fixed exchange rates are decided
by central banks of a country whereas floating exchange rates are decided by
the mechanism of market demand and supply.

Difference between fixed exchange rate and flexible exchange rate

There are various types of exchange rates that are prevalent in the market, but
the most commonly used exchange rate systems are fixed exchange rate and
flexible exchange rate systems.

Fixed exchange rate system is referred to as the exchange system where

the exchange rate is fixed by the government or any monetary authority. It is
not determined by the market forces.

Flexible exchange rate system is the exchange system where the exchange
rate is dependent upon the supply and demand of money in the market.

In a flexible exchange rate system, the value of the currency is allowed to

fluctuate freely as per the changes in the demand and supply of the foreign
exchange.

Fixed Rate Flexible Exchange Rate

Definition
Fixed rate is the system where the government decides Flexible exchange rate is the system which is
the exchange rate dependent on the demand and supply of the
currency in the market
Deciding authority
Fixed rate is determined by the central government Flexible rate is determined by demand and
supply forces
Impact on Currency
Currency is devalued and if any changes take place in the Currency appreciates and depreciates in a
currency, it is revalued. flexible exchange rate
Involvement of Government Bank
Government bank determines the rate of exchange No such involvement of government bank
Need for maintaining foreign reserve
Foreign reserves need to be maintained No need for maintaining foreign reserve
Impact on BOP (Balance of Payment)
Can cause deficit in BOP that cannot be adjusted Deficit or surplus in BOP is automatically
corrected

Foreign Exchange rate

Foreign Exchange Rate:

The rate at which currency of one country can be exchanged for currency of
another country is called the Rate of Foreign Exchange.
It is the price of a country’s currency m terms of another country’s currency. Put
in another way, the rate of foreign exchange is the amount of domestic currency
that must be paid to obtain one unit of foreign currency.

For instance, if 1 American dollar can be obtained (exchanged) for 50 Indian

rupees, then foreign exchange rate is $1 = Rs 50. This (50 to J dollar) will be
called foreign exchange rate between USA and India. In other words, 1 dollar
can purchase 50 rupees of Indian money clearly; the rate of exchange of a
currency simply expresses its external value or its external purchasing power.

Stability in exchange rate is one of the important factors which indicate

economic stability of a country Earnings from exports and payments for imports
are directly affected by the foreign exchange rate .Nominal vs. Real Exchange
Rate.

Nominal exchange rate is price of foreign currency in terms of domestic

currency. Real exchange rate is the relative price of foreign goods in terms of
domestic goods. It is equal to the nominal exchange rate multiplied by foreign
price level and divided by domestic price level.

Symbolically:

Real Exchange Rate = Nominal exchange rate x Foreign price level /Domestic
price level

Foreign Exchange Market:

The market in which national currencies of various countries are converted,

exchanged or traded for one another is called foreign exchange market. It is not
any physical place but is a network of communication system which connects the
whole complex of institutions. It includes banks, specialised foreign exchange
dealers, brokers and official government agencies through which the currency of
one country can be exchanged (converted) for that of another country. Again,
foreign exchange market is of two types—Spot market and Forward market.

Functions:

Foreign exchange market performs three main functions, namely (i) transfer
function, (ii) credit function and (iii) hedging function. Transfer function refers to
transferring purchasing power between countries; credit function refers to
providing credit channels for foreign trade and hedging function pertains to
protecting against foreign exchange risks. Hedging is an activity which is
designed to minimise risk of loss. When people want to operate in the foreign
exchange market, it implies that they intend to buy or sell foreign exchange
depending on their demand for or supply of foreign exchange.

Foreign Exchange Market

A foreign exchange market is where one currency is traded for another. There is
a demand for each currency and a supply of each currency. In these markets,
one currency is bought using another. The price of one currency in terms of
another (for example, how many dollars it costs to buy one Mexican peso) is
called the exchange rate.
Foreign currencies are demanded by domestic households, firms, and
governments who wish to purchase goods, services, or financial assets that are
denominated in the currency of another economy. For example, if a US auto
importer wants to buy a German car, it must buy euros. The law of demand
holds: as the price of a foreign currency increases, the quantity of that currency
demanded will decrease.

Foreign currencies are supplied by foreign households, firms, and governments

that wish to purchase goods, services, or financial assets denominated in the
domestic currency. For example, if a Canadian bank wants to buy a US
government bond, it must sell Canadian dollars. As the price of a foreign
currency increases, the quantity supplied of that currency increases.

Exchange rates are determined just like other prices: by the interaction of supply
and demand. At the equilibrium exchange rate, the supply and demand for a
currency are equal. Shifts in the supply or demand for a currency lead to
changes in the exchange rate. Because one currency is exchanged for another in
a foreign exchange market, the demand for one currency entails the supply of
another. Thus the dollar market for euros (where the price is dollars per euro and
the quantity is euros) is the mirror image of the euro market for dollars (where
the price is euros per dollar and the quantity is dollars).

To be concrete, consider the demand for and supply of euros. The supply of
euros comes from the following:

 European households and firms that wish to buy goods and services from
non-euro countries
 European investors who wish to buy assets (government debt, stocks,
bonds, etc.) that are denominated in currencies other than the euro

The demand for euros comes from the following:

 Households and firms in non-euro countries that wish to buy goods and
services from Europe
 Investors in non-euro countries that wish to buy assets (government debt,
stocks, bonds, etc.) that are denominated in euros

Figure 17.17 "The Foreign Exchange Market" shows the dollar market for
euros. On the horizontal axis is the quantity of euros traded. On the vertical axis
is the price in terms of dollars. The intersection of the supply and demand curves
determines the equilibrium exchange rate.

Figure 17.17 The Foreign Exchange Market

The foreign exchange market can be used as a basis for comparative statics
exercises. We can study how changes in an economy affect the exchange rate.
For example, suppose there is an increase in the level of economic activity in the
United States. This will lead to an increase in the demand for European goods
and services. To make these purchases, US households and firms will demand
more euros. This will cause an outward shift in the demand curve and an
increase in the dollar price of euros.

When the dollar price of a euro increases, we say that the dollar has depreciated
relative to the euro. From the perspective of the euro, the depreciation of the
dollar represents an appreciation of the euro.

Exchange control

Exchange control

Exchange control refers to the policy of the government through which it controls
or intervenes in the foreign exchange market. In other simple words,
government puts restrictions on the sale and purchase of foreign currencies and
refers a measure which influences the foreign exchange rate and closing free
movements of foreign exchange in the country.

In a free market economy, there are no restrictions on the movements of foreign

currencies from inside to outside, but in a planned economy, there are
restrictions and control of the government on the movements of currencies, for
which different devices and methods are adopted. Exporter and other investors
are directed by the government to surrender and deposit the foreign currencies
held by them with the monetary authorities for whom they are paid in home
currency at the prevailing rates of conversion.

Methods of Exchange Control

In order to achieve goals of exchange control, two main methods are applied
which are as under:-

 Unilateral methods
 Bilateral methods

1. Unilateral Methods

In unilateral methods of exchange control, a government applies exchange

control without consultation with other governments. These methods are
discussed are as under;

1. Exchange Pegging

It is the method of exchange control. Exchange pegging refers to the policy of

fixing the exchange value of the current according to some desired rate. When it
is fixed higher than market rate, it is “Pegging up”. but if fixed lower than market
rate, it is known as “pegging down”.

2. Clearing Agreement

Another method of exchange control is clearing agreement. It is an undertaking

between two countries to exchange goods and services in accordance with a
predetermined or specified rate of exchange. This method is applied to check
fluctuation in exchange rate and to maintain equilibrium in balance of
payments.

3. Standstill Agreement

In this agreement the relationship between two countries in terms of capital

movements remains unchanged. Debtor country is allowed to repay her loan in
installments or the short term loan is converted into long term loan.

4. Compensation Agreement

According to this agreement, goods of just equal value are exported and
imported from each other country. Hence, no balance is left and no foreign
exchange is involved.

5. Payment Agreement

In this method, creditor country will export more and more to Creditor County
and the creditor country will import less and less from debtor country to settle
the accounts.

6. Foreign Exchange Rationing

Government has the right to direct all the exports and other investors to
surrender all foreign exchange with the central banks. Foreign exchange, so
collected can be rationed by fixing quota of amount and rate of foreign
exchange.

7. Blocking of Foreigner Accounts

During emergency, a country may block or restrict the foreigners to transfer their
funds in their home accounts. But rarely this step is taken by the countries.

2. Bilateral Methods

In bilateral methods of exchange control, a government applies exchange

control with mutual understanding and consultation of the other government.
These methods are discussed are as under;

1. Clearing Agreement

When two countries agree to settle their accounts in their home currencies,
through their central banks, this method is known as clearing agreement.

2. Moratorium Application

A legal authorization to debtor to stop payment is known as Moratorium. To solve

temporary problems of payment, a country can stop to make payment for
imports and interest on capital.

Objectives of Exchange Control

Exchange control is adopted by the government to achieve following
objectives;

1. Correction of Unfavorable Balance of Payments

This objective is achieved by curtailing unnecessary imports by putting the

restrictions.

2. Protection of Home Industries

In order to protect the home industries from foreign competition, policy of

“protection” is implemented for this purpose; government will not allow the
imports of those goods produced by the home industries.

3. Stabilization of Exchange Rate

The fluctuations in the exchange rate of a country are not favorable for the
economy. It is very necessary to stabilize this rate to create confidence in the
economy.

4. Conservation of Foreign Exchange

Foreign exchange reserves are very important for a country, which is conductive
for all economic development process as it enables the government to import
essential goods for production and defense of the country.

5. Restrictions on Injurious and Harmful Goods

Governments though exchange control restricts the import of injurious and

harmful goods in the country.

6. Helpful in Proper Planning

Government can plan her developing policies and other objectives according to
the available foreign exchange resources and can use them accordingly.

7. Source of Revenue

Exchange controls also may result as a source of revenue for government, it

purchases foreign exchange at a lower rate and sells at a higher rate and then
the difference will naturally generate revenue.

8. Policy of Discriminations

Though exchange control policy of discrimination is adopted, that is, either to

favor or disfavor a country, some better concessions are granted or some more
restrictions are imposed.

WTO and GATT

WTO
World Trade Organisation (WTO) is a permanent international organisation
dealing with global rules of trade between nations. It came into existence in
1995. It is the successor of General Agreement on Tariffs and Trade (GATT)
established aftermath of Second World War. The last round 1986-94 Uruguay
round led to creation of WTO. At the heart of WTO is multilateral trading system.
It consists of WTO agreements negotiated and signed by majority world’s
trading nations and their parliaments. One of important functions of WTO is
smooth trade flow between nations.

Structure:

The WTO has nearly 153 members accounting for over 97% of world trade.
Around 30 others are negotiating membership. Decisions are made by the entire
membership. This is typically by consensus.

A majority vote is also possible but it has never been used in the WTO and was
extremely rare under the WTO’s predecessor, GATT. The WTO’s agreements
have been ratified in all members’ parliaments.

The WTO’s top level decision-making body is the Ministerial Conferences which
meets at least once in every two years. Below this is the General Council
(normally ambassadors and heads of delegation in Geneva, but sometimes
officials sent from members’ capitals) which meets several times a year in the
Geneva headquarters. The General Council also meets as the Trade Policy
Review Body and the Disputes Settlement Body.

At the next level, the Goods Council, Services Council and Intellectual Property
(TRIPs) Council report to the General Council. Numerous specialized committees,
working groups and working parties deal with the individual agreements and
other areas such as, the environment, development, membership applications
and regional trade agreements.

Secretariat:

The WTO secretariat, based in Geneva, has around 600 staff and is headed by a
Director-General. Its annual budget is roughly 160 million Swiss Francs. It does
not have branch offices outside Geneva. Since decisions are taken by the
members themselves, the secretariat does not have the decision making the role
that other international bureaucracies are given.

The secretariat s main duties to supply technical support for the various councils
and committees and the ministerial conferences, to provide technical assistance
for developing countries, to analyze world trade and to explain WTO affairs to
the public and media. The secretariat also provides some forms of legal
assistance in the dispute settlement process and advises governments wishing
to become members of the WTO.

Objectives of WTO

The six key objectives of World Trade Organisation have been discussed below.

1. Establishing and Enforcing Rules for International Trade

The international trading rules by the World Trade Organisation are established
under three separate agreements – rules relating to the international trade in
goods; the agreement on Trade-Related Aspects of Intellectual Property Rights
(TRIPS) and the General Agreement on Trade in Services (GATS).

The enforcement of rules by the WTO takes place by way of a multilateral

system of disputes settlement in the instances of violation of trade rules by
member countries. The members are obligated under ratified agreements to
honour and abide by the procedures and judgments.

2. Acting As A Global Apex Forum

World Trade organisation is the global forum for monitoring and negotiating
further trade liberalisation. The premise of trade liberalisation measures
undertaken by WTO is based on the benefits of member countries to optimally
utilise the position of comparative advantage due to free and fair trade regime.

3. Resolution Of Trade Disputes

Trade disputes, before the WTO, usually arise out of deviation from agreements
between member countries. The resolution of such trade disputes does not take
place unilaterally but through a multilateral system involving set rules and
procedures before the dispute settlement body.

4. Increasing Transparency in The Decision-Making Process

The World Trade Organisation attempts to increase transparency in the decision-

making process by way of more participation in the decision-making and
consensus rule, in particular. The combined effect of such measures helps to
develop institutional transparency.

5. Collaboration Between International Economic Institutions

The global economic institutions include the World Trade Organisation, the
International Monetary Fund, the United Nations Conference on Trade and
Development, and the World Bank.

With the advent of globalisation, close cooperation has become necessary

between multilateral institutions. These institutions are functional in the sector of
formulation and implementation of a global economic policy framework. In the
absence of regular consultation and mutual cooperation, policymaking may be
disrupted.

6. Safeguarding The Trading Interest of Developing Countries

Stringent regulations are implemented by the WTO to protect the trading

interests of developing countries. It supports such member countries to leverage
the capacity for carrying out the mandates of the organisation, managing
disputes, and implementing relevant technical standards.

Roles and Functions of WTO

The broad reach of WTO and its functions have been mentioned below.
· Implementation of Rules for Review of Trade Policy

The international rules of trade provide stability and assurance and lead to a
general consensus among member countries. The policies are reviewed to
ensure that even with the ever-changing trading scenarios, the multilateral
trading system thrives. It also helps in the facilitation of a transparent and stable
framework for conducting business.

· Forum for Member Countries Discuss Future Strategies

The WTO, as a forum, allows for trade negotiations in the multilateral trading
system. In the absence of trade negotiations, growth may stunt, and issues
related to tariff and dumping may go unaddressed. Further liberalisation of trade
is also subject to consistent trade negotiations.

· Implementing and Administering Bilateral and Multilateral Trade

Agreements

The bilateral or multilateral trade agreements have to be necessarily ratified by

the parliaments of respective member countries. Unless such ratification comes
through, the non-discriminatory trading system cannot be put into practice. The
executed agreements will ensure that every member is guaranteed to be treated
fairly in other members’ markets.

· Trade Dispute Settlement

The dispute settlement by the WTO is concerned with the resolution of trade
disputes. Independent experts of the tribunal interpret the agreements and give
out judgment mentioning the due commitments of the concerned member
states. It is encouraged to settle the disputes by way of consultation among the
members as well.

· Optimal Utilisation of the World's Resources

Resources across the world can be further optimally utilised by harnessing the
trade capacities of the developing economies. It requires special provisions in
the WTO agreements for the least-developed economies. Such measures may
include providing greater trading opportunities, longer duration to implement
commitments, and also support to build the sue infrastructure

WTO Agreements:

This is an agreement for implementing the results of the Uruguay Round and
establishing the World Trade Organization, which will be a framework for future
multilateral trade negotiations. The Agreement comprises general provisions on
the WTO’s organization, membership, decision-making, etc.

General Agreement on Tariffs and Trade 1994 (GATT 1994)

The General Agreement consists of: (i) the provisions of GATT 1947 (including
those amended by the terms of legal instruments that have taken effect before
the entry into force of the WTO Agreement); (ii) legal instruments, such as
protocols and certifications relating to tariff concessions, protocols of accession,
etc., that have taken effect under the GATT 1947 before the entry into force of
the WTO Agreement; and (iii) the six understandings that are deemed to be an
integral part of the GATT 1994, such as Article II:1(b) and Article XVII.

Agreement on Agriculture

The Agreement on Agriculture includes specific and binding commitments made

by WTO Member governments in the three areas of market access, domestic
support and export subsidization for strengthening GATT disciplines and
improving agricultural trade. These commitments were implemented over a six-
year period. The Agreement also includes provisions on the implementation of
these commitments

Agreement on the Application of Sanitary and Phytosanitary (SPS)

Measures

This agreement establishes multilateral frameworks for the planning, adoption

and implementation of sanitary and phytosanitary measures to prevent such
measures from being used for arbitrary or unjustifiable discrimination or for
camouflaged restraint on international trade and to minimize their adverse
effects on trade

Agreement on Textiles and Clothing

Textile trade was governed by the Multi-Fiber Arrangement (MFA) since 1974.
However, the GATT principles had been undermined by import protection
policies, etc. The agreement provides that textile trade should be deregulated by
gradually integrating it into GATT disciplines over a 10-year transition period,
which expired at the end of 2004

Agreement on Technical Barriers to Trade (TBT)

Standards and conformity assessment systems, such as industrial standards and

safety/environment regulations, may become trade barriers if they are excessive
or abused. This agreement aims to prevent such systems from becoming
unnecessary trade barriers by securing their transparency and harmonization
with international standards

Agreement on Trade-Related Investment Measures (TRIMs)

In relation to cross-border investment, countries receiving foreign investment

may take various measures, including imposing requirements, conditions and
restrictions (investment measures) on investing corporations. In the Uruguay
Round, negotiations were initially conducted with an eye toward expanding
disciplines governing investment measures. However, the Agreement on Trade-
Related Measures, which was the result of the negotiations, banned only those
investment measures inconsistent with the provisions of ArticleⅢ (principle of
national treatment) and Article XI (general elimination of quantitative
restrictions) which have direct adverse effects on trade in goods. As examples,
the Agreement cited local content requirements (which require that certain
components be domestically manufactured) and trade balancing requirements.
General Agreement on Trade in Services (GATS)

This agreement provides general obligations regarding trade in services, such as

most- favored-nation treatment and transparency. In addition, it enumerates 155
service sectors and stipulates that a member country cannot maintain or
introduce, in the service sectors for which it has made commitments, market
access restriction measures and discriminatory measures that are severer than
those on the commitment table

Agreement on Trade-Related Aspects of Intellectual Property Rights

(TRIPS)

This agreement stipulates most-favored-nation treatment and national treatment

for intellectual properties, such as copyright, trademarks, geographical
indications, industrial designs, patents, IC layout designs and undisclosed
information. In addition, it requires Member countries to maintain high levels of
intellectual property protection and to administer a system of enforcement of
such rights. It also stipulates procedures for the settlement of disputes related to
the agreement

Foreign Direct Investment

Introduction to Foreign Direct Investment:

It is also known as „direct business investment‟. Foreign direct investment

(FDI), according to IMF manual on „Balance of payments‟ is “an investment
involving a long term relationship and reflecting a lasting interest and control of
a residual entity in one economy in an enterprise resident in an economy
other than that of the direct investor. Such investment involves both initial
transaction between the two entities and all subsequent between them and
among foreign affiliates”. Foreign affiliate means a subsidiary company or an
associate in which investor owns a total of at least 10%, but not more than
half of shareholders voting power or branches.

Types of FDI

(i) Market-Seeking:

These are attracted by the size of the local market which depends on the
income of the country and its growth rate.

(ii) Efficiency-Seeking:

In developing countries where capital is relatively scarce the marginal

efficiency of capital tends to be higher than in the developed world where it is
abundant. Assuming that interest rates broadly reflect Marginal Efficiency of
Capital (MEC), it follows that lending rates in Western financial centers are below
MECs in developing countries. Hence, economic efficiency and commercial logic
dictate that capital should flow from the relatively less-profitable developed
world to the relatively more profitable developing countries.

(iii) Other Location Advantages:

These include the technological status of a country, brand name and goodwill
enjoyed by the local firms, openness of economy, trade and macro policies
pursued by the Government and intellectual property protection granted by the
Government. Whatever form of FDI, in modern times, Multinational Corporations
(MNCs) have become the major carriers of foreign capital and technical know-
how.

Features of FDI:

1. It is an investment made by a foreign company in a home country.

2. The foreign company may invest either by opening its branch or by

having a subsidiary or foreign controlled company in home country. It may
have wholly owned subsidiary or joint venture or may acquire a stake in the
existing business.

3. Profit is the prime motive of such an investment. It may be in the form

of a royalty and dividend payments.

4. Investor retains control over investment and management of the firm

concerned. In FDI investor may obtain effective voice in the management
through other means such as subcontracting, management contracts,
franchising licensing trade-marks and patents and product sharing.

5. On the winding up of the firm, the assets may be repatriated to the country
of origin.

According to Section 591 of the Indian Companies Act 1956, “a foreign company
means any company incorporated outside India which established a place of
business within India after or before 1.4.1956.”

The Reserve Bank of India has classified foreign companies into three types:

(a) Subsidiaries in which a single foreign company holds more than

50% of the equity share capital.

(b) Minority companies in which foreign company holdings are 50% or less.

(c) Purely technical collaboration companies which have no foreign

equity participation. They have only technical collaboration agreements.

Foreign companies have also governed by Indian Income Tax Act 1961, MRTP
Act 1969, Industrial Development and Regulation Act 1951, and Foreign
Exchange Regulation Act, 1973.
FDI are governed by long term considerations because these investments
cannot be easily liquidated. In aiming at investment decision, a foreign investor
would have to be convicted that existing comparative „advantages are more
than the comparative disadvantages in a country.

He will compare the improved investment climate in one country with

investment markets in another country. There are many other factors that
influence FDI decisions. They are

(a) Long-term political stability

(b) Government policy of a country

(c) Industrial and economic prospects

(d) Rules about repatriation of profits and disinvestments

(e) Treatment by officials in government departments

(f) Taxation laws.

The recipient country should he cautious at FDI may be harmful if the economy
is highly protected and foreign investment takes place behind high tariff walls.

Role of Foreign Direct Investment in Economic Growth

Foreign Direct Investment helps in accelerating the rate of economic growth as

follows:

i. FDI provides Capital: Foreign Direct Investment is expected to bring

needed capital to developing countries. The developing countries need higher
investment to achieve increased targets of growth in national income.

ii. FDI removes Balance of Payments Constraint: FDI provides „ inflow of

foreign exchange resource and removes the constraints on balance of payment.
It can be seen that a large number of developing countries suffer from balance
of payments deficits for their demand for foreign exchange which is normally far
in excess of their ability to earn. FDI inflows by providing foreign exchange
resources remove the constraint of developing countries seeking higher growth
rates.

iii. FDI brings Technology, Management and Marketing Skills: FDI brings
along with it assets which are crucially either missing or scarce in developing
countries. These assets are technology and management and marketing skills
without which development cannot take place.

This is the most important advantage of FDI. This advantage is more important
than bringing capital, which perhaps can be had from the international capital
markets and the governments.

iv. FDI promotes Exports of Host Developing Country: Foreign direct

investment promotes exports. Foreign enterprises with their global network of
marketing, possessing marketing information are in a unique position to exploit
these strengths to promote the exports of developing countries.

v. FDI provides Increased Employment: Foreign enterprises by employing

the nationals of developing countries provide employment. In the absence of this
investment, these employment opportunities would not have been available to
many developing countries.

vi. FDI results in Higher Wages: FDI also promotes higher wages. Relatively
higher skilled jobs would receive higher wages.

vii. FDI generates Competitive Environment in Host Country: Entry of

foreign enterprises in domestic market creates a competitive environment
compelling national enterprises to compete with the foreign enterprises
operating in the domestic market. This leads to higher efficiency and better
products and services. The Consumer may have a wider choice.

Multinational Companies (MNCs)

Multinational Companies (MNCs):

A multinational company is one which is incorporated in one country (called the

home country); but whose operations extend beyond the home country and
which carries on business in other countries (called the host countries) in
addition to the home country.

It must be emphasized that the headquarters of a multinational company are

located in the home country.

Neil H. Jacoby defines a multinational company as “A multinational

corporation owns and manages business in two or more countries.”

Features of Multinational Corporations (MNCs):

Following are the salient features of MNCs:

(i) Huge Assets and Turnover:

Because of operations on a global basis, MNCs have huge physical and financial
assets. This also results in huge turnover (sales) of MNCs. In fact, in terms of
assets and turnover, many MNCs are bigger than national economies of several
countries.

(ii) International Operations Through a Network of Branches:

MNCs have production and marketing operations in several countries; operating

through a network of branches, subsidiaries and affiliates in host countries.

(iii) Unity of Control:

MNCs are characterized by unity of control. MNCs control business activities of

their branches in foreign countries through head office located in the home
country. Managements of branches operate within the policy framework of the
parent corporation.

(iv) Mighty Economic Power:

MNCs are powerful economic entities. They keep on adding to their economic
power through constant mergers and acquisitions of companies, in host
countries.

(v) Advanced and Sophisticated Technology:

Generally, a MNC has at its command advanced and sophisticated technology. It

employs capital intensive technology in manufacturing and marketing.

(vi) Professional Management:

A MNC employs professionally trained managers to handle huge funds, advanced

technology and international business operations.

(vii)Aggressive Advertising and Marketing:

MNCs spend huge sums of money on advertising and marketing to secure

international business. This is, perhaps, the biggest strategy of success of MNCs.
Because of this strategy, they are able to sell whatever products/services, they
produce/generate.

(viii) Better Quality of Products:

A MNC has to compete on the world level. It, therefore, has to pay special
attention to the quality of its products.

Advantages of MNCs from the Viewpoint of Host Country:

We propose to examine the advantages and limitations of MNCs from the

viewpoint of the host country. In fact, advantages of MNCs make for the case in
favour of MNCs; while limitations of MNCs become the case against MNCs.

(i) Employment Generation: MNCs create large scale employment opportunities

in host countries. This is a big advantage of MNCs for countries; where there is a
lot of unemployment.

(ii) Automatic Inflow of Foreign Capital: MNCs bring in much needed capital for
the rapid development of developing countries. In fact, with the entry of MNCs,
inflow of foreign capital is automatic. As a result of the entry of MNCs, India e.g.
has attracted foreign investment with several million dollars.

(iii) Proper Use of Idle Resources: Because of their advanced technical

knowledge, MNCs are in a position to properly utilise idle physical and human
resources of the host country. This results in an increase in the National Income
of the host country.

(iv) Improvement in Balance of Payment Position: MNCs help the host countries
to increase their exports. As such, they help the host country to improve upon its
Balance of Payment position.

(vi) Technical Development: MNCs carry the advantages of technical

development 10 host countries. In fact, MNCs are a vehicle for transference of
technical development from one country to another. Because of MNCs poor host
countries also begin to develop technically.

(vii) Managerial Development: MNCs employ latest management techniques.

People employed by MNCs do a lot of research in management. In a way, they
help to professionalize management along latest lines of management theory
and practice. This leads to managerial development in host countries.

(viii) End of Local Monopolies: The entry of MNCs leads to competition in the host
countries. Local monopolies of host countries either start improving their
products or reduce their prices. Thus MNCs put an end to exploitative practices
of local monopolists. As a matter of fact, MNCs compel domestic companies to
improve their efficiency and quality. In India, many Indian companies acquired
ISO-9000 quality certificates, due to fear of competition posed by MNCs.

(ix) Improvement in Standard of Living: By providing super quality products and

services, MNCs help to improve the standard of living of people of host countries.

(x) Promotion of international brotherhood and culture: MNCs integrate

economies of various nations with the world economy. Through their
international dealings, MNCs promote international brotherhood and culture; and
pave way for world peace and prosperity.

Limitations of MNCs from the Viewpoint of Host Country:

(i) Danger for Domestic Industries:

MNCs, because of their vast economic power, pose a danger to domestic

industries; which are still in the process of development. Domestic industries
cannot face challenges posed by MNCs. Many domestic industries have to wind
up, as a result of threat from MNCs. Thus MNCs give a setback to the economic
growth of host countries.

(ii) Repatriation of Profits: (Repatriation of profits means sending profits to their

country).

MNCs earn huge profits. Repatriation of profits by MNCs adversely affects the
foreign exchange reserves of the host country; which means that a large amount
of foreign exchange goes out of the host country.

(iii) No Benefit to Poor People: MNCs produce only those things, which are used
by the rich. Therefore, poor people of host countries do not get, generally, any
benefit, out of MNCs.
(iv) Danger to Independence: Initially MNCs help the Government of the host
country, in a number of ways; and then gradually start interfering in the political
affairs of the host country. There is, then, an implicit danger to the independence
of the host country, in the long-run.

(v) Disregard of the National Interests of the Host Country: MNCs invest in most
profitable sectors; and disregard the national goals and priorities of the host
country. They do not care for the development of backward regions; and never
care to solve chronic problems of the host country like unemployment and
poverty.

(vi) Misuse of Mighty Status: MNCs are powerful economic entities. They can
afford to bear losses for a long while, in the hope of earning huge profits-once
they have ended local competition and achieved monopoly. This may be the
dirties strategy of MNCs to wipe off local competitors from the host country.

(vii) Careless Exploitation of Natural Resources: MNCs tend to use the natural
resources of the host country carelessly. They cause rapid depletion of some of
the non-renewable natural resources of the host country. In this way, MNCs
cause a permanent damage to the economic development of the host country.

(viii) Selfish Promotion of Alien Culture: MNCs tend to promote alien culture in
host country to sell their products. They make people forget about their own
cultural heritage. In India, e.g. MNCs have created a taste for synthetic food, soft
drinks etc. This promotion of foreign culture by MNCs is injurious to the health of
people also.

(ix) Exploitation of People, in a Systematic Manner: MNCs join hands with big
business houses of host country and emerge as powerful monopolies. This leads
to concentration of economic power only in a few hands. Gradually these
monopolies make it their birth right to exploit poor people and enrich themselves
at the cost of the poor working class.

Advantages from the Viewpoint of the Home Country:

Some of the advantages of the MNCs from the viewpoint of the home country
are:

(i) MNCs usually get raw-materials and labour supplies from host countries at
lower prices; specially when host countries are backward or developing
economies.

(ii) MNCs can widen their market for goods by selling in host countries; and
increase their profits. They usually have good earnings by way of dividends
earned from operations in host countries.

(iii) Through operating in many countries and providing quality services, MNCs
add to their international goodwill on which they can capitalize, in the long-run.

Limitations from the Viewpoint of the Home Country:

Some of the limitations of MNCs from the viewpoint of home country may be:
(i) There may be loss of employment in the home country, due to spreading
manufacturing and marketing operations in other countries.

(ii) MNCs face severe problems of managing cultural diversity. This might distract
managements’ attention from main business issues, causing loss to the home
country.

(iii) MNCs may face severe competition from bigger MNCs in international
markets. Their attention and finances might be more devoted to wasteful
counter and competitive advertising; resulting in higher marketing costs and
lesser profits for the home country.