Showing papers on "Exchange rate published in 1972"

The Exchange Risks of Foreign Operations

Abstract: Firms that engage in foreign operations are subject to a special type of risk. A foreign operation is obliged to hold assets, incur operating costs, and/or receive revenues whose domestic currency value will change when foreign price levels and the exchange rate change. Investors and corporate financial officers would like to know how such price changes affect the value of foreign operations. Changes in the present discounted value (PDV) of a foreign income stream due to price changes are calculated for a "typical" foreign operation. The PDV technique indicates potential capital gains and losses which are substantially different from those measured by the traditional accounting techniques.' Traditional accounting practices ignore changes in the terms of trade. The PDV technique reveals that fluctuations in the terms of trade may give rise to substantial capital gains or losses. The PDV approach yields results which are applicable to a wide variety of foreign operations. It is applicable to holdings of common stock in any foreign firm; the presence of American management or "control" is not a relevant consideration. The valuation technique also can be used to determine capital gains or losses for export-import operations located either in the United States or in a foreign country. One of the more interesting results is that a firm which produces in the United States for the foreign market may have a greater exposure to the risk of exchange rate and/or price change than an operation which supplies the foreign market from production facilities located abroad.

The determinants of aggregate savings

Abstract: Cross-section data for 70 countries are analyzed in order to explore the determinants of aggregate savings behavior. Saving functions were estimated trying various explanatory variables. The most important variables accounting for gross national savings are capital inflow, per capita income, growth rate, the tax rate, the share of imports in GNP, the exchange rate overvaluation, and the labor participation rate. The share of wages, the rate of price increase, and the mining share in GNP were not significant explanatory variables influencing savings functions. The substitutive effect of capital inflow did not vary with the ratio of imports to GNP. The positive effect of tax rate on savings rate varied inversely with the level of development. The marginal effect of tax rate on gross national saving rate was not different from the average effect. Overall, the whole capital inflow did not markedly change the domestic investment rate. The determinants of the government saving function should be explored more intensively, particularly with the pooled time series data. An attempt should be made to find a function explaining the variation in the incremental saving-income ratio. Graphs and tables are included. 44 references.

Decision analysis for exchange risk management

Abstract: One of the factors which complicates financial decision making in a multinational enterprise is currency devaluations or revaluations in countries where subsidiaries are located. Since exchange rate changes affect the reported earnings, value of financial assets, and future earnings of the multinational corporation, it is imperative that the financial decision maker of such a firm develop a strategy to manage the foreign exchange risk assumed by the firm. It is the purpose of this article to develop relatively formal decision rules for managing the risk of exchange rate change. These rules are based on an analysis of a theoretical decision model of the exchange management process. The inherent uncertainty involved in exchange rate movements is the basic feature of the exchange risk situation. The nature of an optimal decision thus will depend on the attitudes of management toward risk and uncertainty. Four common attitudes will be assumed and examined: minimum variance, minimax, expected monetary value, and expected utility. Each yields a particular set of optimal rules for exchange risk adjustment. Three techniques are available for adjusting the exchange risk posture of the firm. These are (1) adjustment of funds flows, (2) forward contracts, and (3) exposure netting. Adjustment-of-funds-flow techniques involve an alteration in the planned funds flows of parent and/or subsidiaries, in amount and/or currency of denomination, with the view of reducing (or increasing) the local currency accounting exposure of the corporation. This exposure is defined as the difference in local currency assets translated to domestic currency at the current exchange rate and local currency liabilities translated at the same exchange rate. If the objective of management is to decrease exposure, the technique must increase local currency denominated liabilities or decrease local currency denominated assets. Techniques for increasing liabilities include local borrowing and stretching payables. Techniques for decreasing assets include reduction of cash balances and other liquid assets, reduction in investment in accounts receivable (either by tightening credit terms or factoring), and reduction in inventory investment (if inventories are translated at the current exchange rate). Each of these techniques generates local currency funds. If exposure is to be reduced, these funds must be used to acquire assets which are not exposed to the exchange risk. For example, if the parent corporation had planned to provide domestic currency funds to the subsidiary, locally generated funds can replace funds from the parent. Alternatively,

The Developing Countries in a World of Flexible Exchange Rates

Abstract: The bias built into the politics of many countries against changes in parities of their exchange rates has meant that the degree of flexibility provided by the Bretton Woods system has not been fully used. Governments have thus deprived themselves of at least one instrument of policy in their attempts to reconcile internal and external objectives of policy. The result has been restrictions, protection and, in some cases, inhibitions of growth. These have had detrimental effects on the flow of trade and capital to the developing countries.

Uncertainty, Currency Areas and the Exchange Rate System

Abstract: The uniqueness of international finance reflects the multitude of national currencies. Both benefits and costs are attached to separate national currencies. Each country with its own currency can pursue an independent monetary policy. Various costs are incurred with the foreign transactions associated with international payments. These costs are avoided in a unified currency world, since there is no exchange market, but the advantages of independent monetary policies are not attained. The trade-off between the advantages of independent monetary policies and the costs of exchange markets involves optimization, both of the number and scope of national currency areas and also (of greater immediacy) in the type of exchange rate system-the choice between pegged rates and floating rates and among various types of pegged systems. The frequent exchange crises in recent years have indicated that the International Monetary Fund system of adjustable pegs has not been functioning well. National authorities have been reluctant to change the parities; variations in ad hoc controls on foreign payments have compensated for sticky exchange pegs. These controls constitute selective changes in exchange rates, so that a system of multiple exchange rates has resulted. The rationale for the commercial policy approach to international adjustment is that the political costs associated with changes in the exchange rate are avoided. Floating exchange rates are sometimes viewed as a way to attain greater flexibility and yet avoid the political costs associated with changes in parities. Other proposals for increased flexibility seek to retain elements of the pegged system so as to minimize uncertainty in the exchange market and the likelihood of disorderly national behaviour in it. The proposals for wider support limits, crawling pegs and sliding bands differ in terms of the frequency and method by which the parity is changed and the width of the support limits around the parity.' This paper identifies economic criteria which provide a basis for

A long-run economic growth model for developing countries

Abstract: Publisher Summary This chapter discusses a long-run economic growth model for developing countries. A general equilibrium framework for approaching the long-run problems of economic development is obtained by emphasizing the supply rather than the demand for outputs. The economy of developing countries is first disaggregated into three producing sectors: the primary or agricultural sector, the secondary or manufacturing sector, and the tertiary or service sector. The industry production function at a given point in time is a function of capital in buildings and capital in equipment, labor, and (for agriculture) land. The two endogenous variables of the model that affect total exports are the exchange rate E and the general domestic price level P. A distinguishing characteristic of less-developed countries is that while producers do attempt to maximize profits, they are less accurate in achieving their goal than their counterparts in developed economies—the variance of actual profits around the point of profit maximization is greater in underdeveloped countries.

The effects of protection on the growth rate and on the need for external assistance

Abstract: The Effects of Protection on the Growth Rate and on the Need for External Assistance try Stephen R. Lewis , Jr. Host studies of protection in developing countries arc concerned with questions of static losses of real output or inefficient resource allocation at some point of time. These studies are often criticised as not relevant to problems of development. This paper incorporates the effects of protection into the most widely used macro—economic projection model, the 'two—gap" model of Chenory and Strout, and examines some dynamic implications of protection. The adaptation of the two-gap model explicitly allows for two facts related to protection: 1) The apparent amount of import substitution or foreign exchange saving, overstates the actual, import saving if the new industry is protected. 2) The apparent amount of export growth or new foreign oxchango earned, is undcrstated whenever protection applies only to import substitutes. • • Thus, the presence of protection will cause the usual macroeconomic projection models to understate import demand whenever conventional definitions of value added are used, if there is emphasis on import substitution behind protection in the plan period. The adaptation to the model makes it qui+e clear why oountries pursuing industrialization by means of protection often run into balance of payments difficulties; The factor payments generated in import—substituting industries cxceed the value of foreign exchange saved in the industry sometimes by substantial amounts. For countries like Kenya, Uganda and Tanzania with a high marginal propensity to import, and for industries s and more particularly, that while there may be sufficient increases in potential domestic saving to cover the increase in planned investment, the level of investment and the rate of growth of output that arc planned -yould generate more import demand^than can. be covered by export supply, and unless foreign assistance can cover tho projected "import gap" the rate of investment (and the rate of domestic saving) will have to be adjusted downward to meet the balance of payments constraint. The logic of the two-gap analysis is heavily supply oriented. It argues that there must be a change in the structure of production in the economy to increase the output of traded goods (import substitutes and exports) in order to bring the balance of payments into a long-run equilibrium. But, since the investment process takes time, foreign assistance can supplement the earnings of foreign exchange from exports and permit a movement to a sustainable higher rate of growth than would be possible with export earnings as the only source of foreign exchange. The purpose, .of. this ..paper is to modify the usual two—gap analysis . of trade and growth to take into account the fact that foreign trade policy, in particular protection to the import-substituting sectors, has substantial macro—economic effects in the economy. These effects can bo systematically incorporated into the two—gap analysis to give both a better understanding of the effects of protection on the macroeconomic behavior of the economy, and a better (more accurate) method of projecting the balance of payments consequences of any given investment'program (or plan) in the context of any given system of import substitution protection. A by—product will be a more accurate set of projections of the "requirements" for foreign assistance for any given plan under a given set of import tariffs (or equivalent import quotas)„ Thus, whatever the choice of.the level of protection to be given to import-substituting industries, the revised model will give better means of predicting the balance of payments consequences than the existing two—gap models. Why this is so will become apparent in the course of the paper. The next section looks at the relation of protection to measured value added in each sector, and to the net foreign exchange earning or saving that is done in any sector. Section III presents the formal modification of the model to take trade and protection policies into account. Section IV looks at the implications of this modification for the rate of growth of output and investment, for the balance of payments, and for the "requirements" of foreign, assistance. Section V discusses a few qualifications, to' the results? and Section VI gives a brief summary. To anticipate the.conclusion, the ironic result of the analysis is that, other things equal, the more a plan concentrates its investment resources on protected import substituting industries, and the greater the level of protection these industries,receive, the greater will be the requirements for foreign capital inflow to meet plan targets, and the sharper will be the balance of payments constraint facing the economy. The failure to take account of protection in projections of the balance of payments will result in a systematic understatement of the demand for imports, and will produce balance of payments difficulties where none were anticipated in the plan. PROTECTION AMD VLAUE ADDED The key modification in the two—gap analysis of trade and growth involves the adjustment of value added in the sectors producing tradeable output for the effects of protection and currency overvaluation. What we need for this purpose is the notion of "protection to value added", or "effective protection," as it is known in the literature. A variety of critiques have, been written on the theory of effective protection. Host pf the critiques argue that, due to possibilities for substitution, it is not possible, a priori, to tell accurately the extent of protection a sector is receiving, or the amount of productive factors that are .engaged in a sector relative to a free-trade situation. This conclusion is reached because in a different situation with different factor, input, and product prices, the choice of inputs, factors, and the output mix would change, and the existing coefficients are not a good guide to the coefficients that would be chosen under those different conditions. While" I concur with this objection, it does. not. apply to. the use that is made of effective rates of protection here. The nominal rate of protection to a good,t^, measures the percent by which its domestic price exceeds its world price at the official exchange rate* (Note that quantitative import restrictions will push the domestic price even higher than that implied by a tariff if the restrictions, rather than the tariff, arc the binding constraint on the level of imports.) If Q. is the.domestic value of imports (or importables) -"V and Q^ is the world value c.i.f.,

The impact of direct trade controls and an overvalued exchange rate on factor proportions in manufacturing

Abstract: This paper is an analysis of certain aspects of manufacturing development under a regime of import and foreign exchange controls, where such controls are accompanied by an overvalued exchange rate. The analytical framework is a modification of the ‘effective rate of protection’ analysis. The argument proceeds from the fact that the overvalued rate represents a subsidy on imported capital equipment and intermediate goods. Two implications are drawn from the analysis. First and most important, the subsidy on imported intermediate goods will exacerbate the oft‐noted tendency of import‐substitute industry to take the form of ‘processing and packaging’ operations with minimal domestic value added. Second, the subsidy on imported capital equipment will give entrepreneurs an incentive to substitute imported capital equipment for domestic labour.

A study of inflation in Pakistan, 1955-1968

Abstract: Pakistan has experienced significant inflationary pressures in the course of her economic development. Although inflation was often repressed by Government controls, estimates based on free market prices existing alongside the controlled prices indicate that inflationary pressures have most of the time been quite significant. The price inflation has also been partly diverted towards the balance of payments pressure. Monetary expansion, caused by large deficit financing operations in the Government sector and bank financed development expenditures in the private sector, was often supplemented by substantial increases in income velocity. Nevertheless, monetary factors do not seem to have played as vital a role in generating the inflationary pressures as the structural factors like chronic food shortages and foreign exchange bottlenecks. Government's agricultural and commercial policies were greatly responsible for these shortages. Foreign economic aid and the P.L. 480 food imports relieved the general inflationary pressures considerably and played an important stabilizing role. Nevertheless, the pressure on prices and balance of payments has always been significant. Evidence shows that inflation has not given much support not to economic growth. Real savings and capital formation have/been so much encouraged by rising prices as by the availability of capital goods and raw materials. Profits have been mainly determined by the degree of competition rather than by the rising prices. On the whole, high rates of growth in the economy have been associated with low rates of inflation. On the other hand, inflation has distorted the distribution of real income. Real wages have often been adversely affected by the rising cost of living and the brunt of inflation has been borne mainly by the working classes whose wages have risen very reluctantly in the process of inflation due to high unemployment and abundant supply of labour. More stable economic growth in future would require sound agricultural development in future Plans and larger food supplies. Likewise, increased foreign exchange supplies both through exchange rate manipulations and foreign capital inflows together with relatively liberalized imports can ensure more efficient economic growth. Improvements in the fiscal and monetary management, lesser reliance on deficit finding and increased tax efforts would also be warranted in the interest of stable and efficient economic development.

Overinvoicing and Industrial Efficiency

Abstract: Much of the corruption1 in Pakistan industry stems from an unrealistic official exchange rate. The dollar sells for Rs. 4·75 in the official market but for two to three times that much in the free market, allowing handsome profits for those who can trade in both. This paper describes how corruption works through overinvoicing of capital equipment imports. Moral dimensions of the problem are ignored; the central question is how over-invoicing affects the allocation of investment and therefore the structure of industry — how (and by how much) over-invoicing changes the costs of capital to the men who make investment decisions.2 The logic of the problem can be developed with simple equations but an understanding of overinvoicing and its consequences does not depend on algebra. The reader who finds equations more a hindrance than a help can omit them and still get a clear sense of the shape and magnitude of the problem.

A Report on the Fund

Abstract: Like most revolutions, the movement which culminated at Bretton Woods in July 1944 was the product of its time. Three main considerations motivated the pioneers of that movement. These were, first, a realization that, as a result of the war, the international economy had been violently disrupted; second, a fear that after the war the vicious cycle of boom and slump would be repeated; and, third, a recognition that to cope with these problems much greater international co-operation would be necessary than had prevailed before 1939.

Exchange rate problems in national accounting of developing countries

Abstract: Developing countries which typically have import surpluses and inflationary pressures because of insufficient savings are prone to use indirect taxes on imports (Tm) and subsidization of exports (Sx) in order to prevent deterioration of the balance of trade. If these substitutes for devaluation are included in the net indirect tax component of product at current market prices (Ym) the import surplus is likely to be understated, and Ym upward biased. This distortion will be avoided if imports and exports are measured at effective exchange rates (ER), that is, at official rates (OR) plus Tm and Sx respectively, and if (Tm - Sx) is deducted from the net indirect tax component of Ym. Only in this manner become imports and exports consistent with the other uses and resources at market prices and can be articulated with them. At base-year prices the volume index of product at OR diverges from that of ER to the degree that the composition of imports and exports in regard to tax and subsidy rates computed ad valorem significantly changes. Such a case is similar to that of the price indexes of imports and exports moving in diverging proportions: the trade balance at base-year prices will differ from that at current prices. The resulting discrepancies in national accounts have led to proposals of deflating, for example, exports by the price index of imports. Suchlike approaches are incompatible with the principle of national accounting that prices are supposed already to measure substitution values. Deflating exports by import prices means reintroducing substitution values, as does, for example, deflation of incomes by a consumer price index. Correspondingly, since the trade balance at ER conceptually expresses the value of imports at domestic market prices as compared to the corresponding domestic market value of exports, and if at ER the trade balance diverges from that at OR, the former balance has an important meaning (as has the trade balance at base-year prices as compared to that at current prices) and the resulting discrepancy between the two measures should not be removed merely for the sake of accounting smoothness. In contrast to the market price approach, the measurement of product at base-year factor cost is indifferent to the measurement of the trade balance at ER and at OR. It is, therefore, proposed in countries in which part of import taxation and export subsidization substitutes for devaluation, to record imports and exports in the national accounts at effective exchange rates, and to correct the net indirect tax component of product correspondingly. Imports and exports at official exchange rates should be shown within the balance of payments, and the latter separately as a memorandum item.

International monetary rules and external disequilibrium in developing countries

Abstract: Internationale WAhrungsvorschriften uAu\eres Ungleichgewicht in EntwicklungslAndern. — Die vorliegende Abhandlung vertritt die Auffassung, da\ die »AnnAherung« zwischen dem Bretton-Woods-System und den weniger entwickelten LAndern zu unzureichenden und unwirksamen Ma ahmen der Au\eren Anpassung fur die weniger entwickelten LAnder gefuhrt hat.